Business | Investment
Push comes from India and China
It is still not clear if prices rising in the UAE are due to the dollar peg, but there appear to be production and import control problems.
- By Dr. Hugo Toledo, Special to Gulf News
- Published: 00:19 January 26, 2008
Global inflation is rising even as the global economy is slowing. How much should policymakers worry? Actually, a lot.
It appears that stagflation - the combination of low output, high unemployment and high inflation - is returning after several years. It is no secret that the rapid rate of economic growth in China and India has raised the price of raw materials significantly. If unmatched by supply, that certainly results in high prices.
For now, raw material prices will continue to fuel world inflation until the rates of econ-omic growth of China and India decrease to their long-run sustainable level.
Inflation in the UAE is not clearly due to the dollar peg, but similarly to China, there appear to be production and import control problems.
On the production side we have not enough housing and schools being built to accommodate demand. Imports being concentrated in the hands of a few importers prevent an increase in the flow of imported consumer goods to meet the rising demand.
Last week, the US Federal reserve lowered interest rates by 0.75 per cent and the UAE Central Bank followed suit. Economists in the UAE are scratching their heads by this move.
How is it possible that central bankers in a growing economy like the UAE's would lower interest rates by so much?
No choice
UAE monetary policymakers argue they have no choice; their hands are tied because of the peg. In reality, the peg does not imply interest rate equalisation unless both countries are rated with identical risk. However, in the eyes of international investors, the US and the UAE are not viewed as countries equally attractive to foreign investment.
In fact, because of its geographic location and instability in the region, the UAE is viewed as a riskier place to invest than the US which has been considered over many years a safe heaven for investment. Interest rates and risk always move in the same direction.
Adjusting for country or regional risk differences gives the UAE Central Bank the leverage it needs to manage interest rates. We do not want to keep interest too high relative to that in the US because it may send the wrong signal to investors, but on the other hand, there is no need to match it on a one-on-one basis.
The interest rate influences inflation indirectly via domestic demand for goods and services and via the exchange rate. When interest rates fall, it is less profitable for households to save, thus households tend to increase their consumption now rather than later. Borrowing also becomes less costly, thus investment increases.
2008 can become a very challenging year for UAE monetary policymakers. Without other action, we should expect higher prices and upward pressure on wages.
- The writer is Head of Department of Economics at The American University of Sharjah.
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