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What's the best policy choice?
Talk is cheap, so the cliche runs. Right now though, so is the dollar. In the GCC, a dip in the latter has led to a glut of the former, as the region's governments decide how best to combat imported inflation.
- By Oliver Cornock, Special to Gulf News
- Published: 00:32 February 16, 2008
Talk is cheap, so the cliche runs. Right now though, so is the dollar. In the GCC, a dip in the latter has led to a glut of the former, as the region's governments decide how best to combat imported inflation.
Their options are distinctly limited. In the absence of an independent monetary policy, the GCC is constrained to follow the Fed. In the past few weeks, this has led to a cut in interest rates of 150 basis points. This fiscal loosening is the precise opposite of what is needed in the Gulf right now: Saudi inflation hit a 16-year high of 6.5 per cent in December, and Merrill Lynch is predicting figures as high as 12 per cent for the UAE.
In an unpegged economy, the answer would be obvious: tighten money supply directly by raising central bank interest rates. In pegged currencies such as all bar one of the GCC's, this option is not available. Interest rates have to follow those of the peg - in this case, the Fed. As a result, government response is constrained essentially to two levers: indirect fiscal tightening (narrowing the money supply), and revaluation. The problem for the GCC is that one of these levers is probably too small, while the other is probably too big.
Take the first, which is being encouraged by Gene Leon of the IMF. He thinks Gulf states should reduce the amount of money available to spend, arguing revaluation would have only a short-term effect on prices. Governments can curb liquidity in a number of ways - sovereign wealth funds are one handy way to get rid of their excess dollars.
Shooing away liquidity is a small lever though. Bigger money supply levers target the domestic economy, and require actions such as cutting government spending and government pay, and running a fiscal surplus. Unfortunately, these are either par for the course in the Gulf, or not on the cards. Try explaining to your people they should take a pay cut when your chief export is at $90 a barrel, and rent, food and energy prices are rising at record levels. A case in point would be Oman, where record inflation of 8.3 per cent has just been noted for December. In response, the government announced a plan to increase government wages by 43 per cent.
This leaves the GCC with its second option: revaluation, or even de-pegging. Kuwait jumped the gun last May, shifting to a basket. With the dollar still refusing to stage a recovery though, some strong signals have been emanating from Qatar and Saudi Arabia in the past week that they may soon follow suit.
Revaluing, or even dropping the peg, brings its own risks. In the short-term, consumer prices would fall as the buying power of the currency rises. However, the long-term repercussions are less predictable. The effect on prices is likely to be no more than short-term, and confidence in the dollar, the world's reserve currency, will be further eroded.
A McKinsey report placed oil-exporters alongside East Asia as the world's largest net suppliers of capital - a position they have not held since the 1970s. A lack of confidence in the dollar by them will further darken the currency's outlook.
- The writer is Oxford Business Group's Regional Editor in the GCC.
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