We need to learn to live with inflation

 

His Highness Sheikh Mohammed bin Rashid Al Maktoum, Vice-President and Prime Minister of the UAE and Ruler of Dubai, and Chinese President Hu Jintao may well have discussed their nation’s shared level of economic success over the last decade in Beijing this week but they are just as likely to have shared their views on inflation – the beast haunting both the UAE and China of late. 


The most recent data from the Emirates showed that inflation levels in Abu Dhabi had surpassed 10 per cent in 2007, an indicator of what overall inflation in the country is likely to be at in 2008. Similarly, China’s February consumer price index (CPI) reading was up 8.7 per cent against 2.9 per cent one year ago. The CPI for all of 2007 was only 4.8 per cent.

In contrast, China has a little more fiscal flexibility in its battle against soaring prices. Beijing has raised interest rates and reserve requirements many times over the last year and announced sharp new limits on bank lending. The UAE is, of course, tied to US monetary policy but has used bank capital reserve requirements as a tool to fight the good fight. However, in the short term there is unlikely to be any respite. Economic policies usually need the medium to long term to bear fruit.

Yesterday’s comments from the UAE Vice-President that “inflation will solve itself… will level off” are instructive. We are behind the curve. Inflation has been dealt with. We should not fear its shadow. But is it right that we shouldn’t worry about it? Certainly, inflation is a player in any booming economy.

And many economists, including former Fed chairman Alan Greenspan, have time and again played down the impact of inflation on the global economy. The problem the US has, for example, is that its banks won’t lend money right now. The Fed has also shown that controlling inflation is lower down its list of priorities than stimulating the economy by lowering interest rates to 2.25 per cent.

There is also a weight of opinion thrown down on the side of the argument that higher prices – both oil and food – are a long-term phenomenon of global markets that we will have to accept and live with.

China’s inflation, for example, is mainly being fuelled by high food prices – which have risen by more than 20 per cent in the last 12 months. Of course, the UAE has its own issues driven by internal factors but is still a victim of the same trend.

Not all global trends necessarily impact the local economy, however. Sheikh Mohammed underlined how well insulated the Emirates is from the global credit crisis, for example, yesterday, saying that it “will not affect us, because we are prepared for it… It may go on longer than anticipated, but it won’t affect us”. But there is no denying that rising inflation is a characteristic now common to all economies both in the developed and developing world.

The property boom and dearth of accommodation in the UAE have fuelled inflation but we also must learn to live with higher prices of food, oil and other essentials for the foreseeable future.

We must also learn to live with being tied to the US dollar. The best policies are put in place for long-term benefits and the stability offered until recently by the dirham’s peg to the greenback is the foundation on which the current boom has been built upon. 

There is no doubt that the merits of the peg and the arguments for and against it have been discussed and studied intensely within government. Sheikh Mohammed’s remarks yesterday that a committee has been studying the issue cannot be a surprise.

Such comments are designed to dampen the speculation since Kuwait’s decision last year to move its peg to a basket of currencies.

The theory goes that once a GCC nation takes a step forward the others will follow sooner or later. But this is wishful thinking. Gulf states do not take unnecessary risks. Particularly if the weakness of the US dollar, like inflation, is here to stay.

A wider and more urgent issue fuelling inflation is the unprecedented rate of government spending in the region. Both Saudi Arabia and the

UAE have pumped billions of dollars into public and private projects,

from infrastructure to aviation, as part of policies to create wealth

and jobs.


This spending has driven the money supply higher – doubling in 2007 – but is a necessary and essential exercise in order to sustain future generations. Curbing such expenditure will do more than dropping the dollar peg to slow down the rate of inflation.

(Mustafa Alrawi is the Managing Editor of Emirates Business)
 
 
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