Last December speculation about a possible revaluation of Gulf currencies reached a peak before a meeting of heads of state. Since then clear statements emphasising the commitment to the dollar-peg and current exchange rate levels have been issued. But the hyper-inflation that economists flagged up has arrived, and the promised recovery of the US dollar has not. Is it time to think again on revaluation?
Inflation levels have picked up again across the GCC this year. We have Saudi Arabia officially in double-digits for the first time. In the UAE the dampening of rental inflation by new supply has not happened; apartments are fetching 20 per cent more in rent than a year ago in Dubai and the Colliers International survey of Abu Dhabi pointed to a 22 per cent increase in rents and 53 per cent increase in house prices.
Six months ago it seemed reasonable to argue that imminent new supply in Dubai – such as the Jumeirah Beach Residence and Jumeirah Lake Towers in New Dubai – would bring rental inflation under control. But the demand for property has proven so strong that this forecast has been shown to be incorrect and the inflationary spiral in prices is clear. Food prices are another critical area. Governments are imposing price controls on basic products but the prices of every other kind of food product are spiraling higher. It is just not possible to regulate every last cornflake, and if margins are squeezed too tight then this risks creating shortages of the most basic products.
At best price controls are a temporary solution to inflation, at worst they interfere in the operation of a free market and create more problems than they solve. Rent caps are similar. They work in the short-term but in a region like the GCC with its high turnover of expatstaff there is only ever a short delay before landlords can apply the market rent.
Inflation is also distorting fuel costs. Diesel in Dubai costs double what it does in neighbouring Abu Dhabi because the latter has its own refinery and can subsidise costs. A bag of fertiliser for the garden is now Dhs240 whereas a month ago it cost Dhs100. It really is amazing how in such a short time – no more than a year or two at most – inflation can produce market distortions even in an economy as open to free trade as the Emirates. The big hope at the start of the year for policy-makers was the US dollar would bottom out and begin to recover.
For let us not forget that it is the weakness of the dollar that has made import prices rise for many goods in the Gulf. Oil is priced in dollars. But the majority of imports is from Europe and therefore cost more if the dollar devalues.
It was always open to some debate as to whether the dollar would recover. Certainly the further rate cuts by the Federal Reserve this year have done nothing to strengthen the dollar. Rates are now at two per cent and the question is whether they will go lower. Optimists say the rate cuts are over and just as soon as the US economy shows signs of recovery then rates will actually go up.
But this is nonsense. US house prices are falling and even optimists reckon that they will not bottom out until the middle of next year. How can the Fed raise rates in that environment? Indeed, is it not more likely US equities will increasingly look overvalued with corporate profits likely to disappoint this year, and if the stock market tumbles then the Fed may well cut rates again. They could go to one per cent or even zero.
That will leave the Gulf states with hyper-inflation and an even more wholly inappropriate interest rate regime. Even the US Treasury appears to be conceding that the US dollar peg is looking an increasingly untenable policy option for the Gulf states. The latest US Treasury report to Congress on International Exchange Rate Policies recognises the inflationary pressures that the dollar peg is putting on the Gulf states, which Merrill Lynch says is a green light for revaluation. This is a highly significant report because it is widely believed US opposition to revaluation is the one reason that it has not happened this year.
Certainly from any common sense standpoint the maintenance of the current exchange rate regime stands ultimately to damage Gulf economic interests by producing a boom-to-bust economic cycle of significant proportions. And almost anybody who has studied economics will draw the same conclusion. This is text book economics not scare mongering.
For very high inflation levels distort investment into real estate and financial services, starving other sectors of resources, and then inflate prices to levels that are unsupportable in even the most minor setback. Preemptive action by Gulf central bankers to keep this economic boom under some kind of control through revaluation and currency reform is therefore something which should be considered before it is too late.