Business | General
Combating the price-rise monster
The UAE is suffering from high inflation because of high liquidity, supply shortages and rising costs of imports due to the weakness of the dollar to which the dirham is pegged.
- By Babu Das Augustine, Banking Editor
- Published: 01:41 December 3, 2007
Dubai: The UAE is suffering from high inflation because of high liquidity, supply shortages and rising costs of imports due to the weakness of the dollar to which the dirham is pegged.
The UAE, like its Gulf neighbours, is in the middle of an economic boom. Traditionally, in boomtown economies, supply and demand distortions exist, money supply grows and inflation rises - all at one go.
The most unpalatable derivative of this growth story is inflation, which is a byproduct of high money supply and high growth. While a pay hike can only temporarily address the issue, the money supply should be tamed with fiscal and monetary policy mechanisms.
While the UAE's money supply increased more than 20 per cent in 2006, according to the latest central bank statistics, it grew by more than 15 per cent in the first half of 2007 and is projected to be above 18 per cent for the whole of 2007.
"Inflation should be handled with fiscal and monetary policy measures. In the case of the UAE and other GCC countries, fiscal tightening is difficult as most governments are trying to diversify their econ-omies by investing their excess liquidity in infrastructure investments.
"Currently, monetary policy measures are virtually absent because of the peg to the dollar. Given the current situation, governments should look at flexible exchange rates to fight inflation," said Marios Maratheftis, regional head of research for the Middle East North Africa and Pakistan for Standard Chartered Bank. While excess liquidity is the dominant factor in the UAE's inflation, rising food and housing costs also play a big role.
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The UAE is a large importer of food, which has a weightage of 14 on its Consumer Price Index. The fact that food is mainly imported suggests that the weakness of the dirham on a trade-weighted basis is inflationary.
Last year, prices of corn, soybeans and wheat rose due to disturbances in weather patterns and the demand for biofuels. The IMF estimates that the contribution of food inflation to overall inflation for January to April 2007 is more than 50 per cent for the Middle East.
In the GCC, Saudi Arabia, Oman, and Kuwait, the countries whose baskets are most heavily weighted towards food, are dealing with the most significant increases in food prices.
Because of the dirham's peg to the dollar, interest rates are kept low, which limits the ability of the authorities to drain liquidity out of the system. The absence of a mature bond market and the use of open market operations to rein in liquidity are also serious constraints.
Additionally, due to the heightened speculation that the dirham is likely to be revalued there have been significant inflows of money.
"Speculation has resulted in the purchase of GCC currencies rising dramatically. The higher holdings of GCC currencies are putting significant downward pressure on local interest rates, causing further increases in the money supply," said a recent report from Standard Chartered.
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