Domestic conditions contribute much to inflation

Doing away with inflation in the Gulf Cooperation Council (GCC) nations is undoubtedly a daunting task. Double-digit inflation rates are now commonplace not only in Qatar and the UAE but in other GCC states as well. Last year, Qatar and the UAE suffered from inflation rates of 14 per cent and 11 per cent respectively.

Still, inflation rate in Saudi Arabia stood at 10.5 per cent in April, easing slightly to 10.4 per cent in May. Also, Kuwaiti inflation rate stood at 10.4 per cent in February, up from 9.5 per cent in January and still a lower 7.5 per cent in December 2007. Still, inflation rate reached a record 12.4 per cent in Oman in April. Notwithstanding official figures, inflation rate in Bahrain is believed to have passed 10 per cent in the last few months.

Housing and food costs are chiefly responsible for the ever growing inflationary pressures throughout the region. In the case of Saudi Arabia, rents, fuel and water increased by 18.5 per cent in May. Yet, food and beverages grew by 15.1 per cent in the same period.

By one account, imported inflation is responsible for as much as 30 per cent of overall inflationary pressures encircling regional economies. This is a direct result of adverse effects of having GCC currencies linked to the dollar, in turn suffering from declining value. Kuwait has linked its currency to a basket of currencies that includes the greenback.

Well-placed Kuwaiti sources have disclosed to this writer that the dollar constitutes some 60 per cent of all currencies included in the basket. So is the case due to the significance of the dollar in Kuwait's weighted international trade.

De-linking the currencies with the dollar would not overcome inflationary pressures. Declining value of the dollar is merely part of the problem, a matter clearly demonstrated in the Kuwaiti experience. At any rate, GCC countries can elect to end the dollar link, as this is a sovereign choice.

To be sure, a significant portion of inflationary pressures stems from domestic economic conditions. Reference is made to the sharp growth of public sector spending, which averaged around 17 per cent in 2007. In contrast, budgetary expenditures grew by merely three per cent in 2002. The sharp rise in public expenditure is the result of stronger oil revenues. The authorities are using the extra oil proceeds to help local people adjust to inflationary pressures.

All GCC governments have increased public sector employees in the last 12 months. Only recently, the Kuwaiti authorities agreed to a demand made by the newly elected parliament to increase salary of Kuwaiti nationals working in both public and private sectors by 50 Kuwaiti dinars ($182) for those earning less than 1,000 dinars monthly. Yet, a good amount of government spending ends in capital projects. GCC governments have no choice but to invest rising oil proceeds on infrastructure projects such as road network and utilities to offset demand.

At the same time, M2 or broad money supply is growing at exceptionally high rates. The growth averaged around 30 per cent in 2007, up from 10 per cent in 2003. M2 consists of currency outside the banking system plus private demand and savings (short and long-term). The growth of M2 reflects the mood amongst the mood of consumers and investors.

Containing inflationary pressures requires the adoption of a mix of monetary and fiscal policies. These entail restricting growth of public sector spending, as part of a broader fiscal policy. Other options may be placing a cap on rental rises, a policy currently in practice in Qatar and Dubai.

The writer is a Member of Parliament in Bahrain.