GCC Focus: Oil and dollar rekindle inflation fears in Gulf states

In retrospect, inflation was the order of the day in GCC economies in 2007, reaching as high as 14 per cent in Qatar and 11 per cent in the UAE. The unpleasant state was the consequence of rising oil prices together with the declining value of the American currency.

The price of oil reached as high as $147 (Dh539.97) per barrel in July 2008, but then it dropped to nearly $40 per barrel by yearend.

The fall reflected changing global sentiments following the collapse of subprime markets in the US. Yet, eruption of the financial crisis caused other problems including a confidence problem for stock markets and real estate.

Oil prices recently hovered at $75 per barrel on the back of the gradual return of confidence in global economies. The renewed sentiments partly reflect determination by the G20 countries to spur growth in global economies.

Leaders of the G20 met in September in the American city of Pittsburgh, their third since the emergence of the global crisis in 2008.

Yet, economic well-being translates into growing demand, in turn paving the way for higher oil prices. Understandably, firmer oil prices force importing countries to raise the value of exported products to make up for higher operating costs.

Lower value

Coincidence or not, the declining value of the US dollar is taking place during firmer oil prices.

To be sure, the greenback has lost some 18 per cent of its value against the euro since March. The lower value of the dollar translates into higher prices of imports from currencies not pegged to the greenback.

GCC economies partly depend on euro zone countries and China for a considerable amount of their imports including vehicles and machinery.

All GCC countries except Kuwait link their currencies to the US dollar as a conscious economic policy. The link is meant to provide confidence in regional economies and give investors the opportunity to do business notwithstanding fluctuations in exchange rates. In the case of Kuwait, the dollar makes up 60 per cent of its basket of currencies.

This is the case because a considerable amount of Kuwaiti exports, including oil and petrochemicals, are priced in dollars.

More specifically, increases in the value of imports together with the decline in the value of the dollar created a problem of imported inflation for GCC countries. By one account, imported inflation was responsible for as much as 30 per cent of overall inflationary pressures that encircled GCC economies in the past few years.

Increased spending

Firmer oil prices encourage GCC countries to increase spending, thereby adding to threats of renewed inflationary pressures. GCC countries used oil rates of $40 to $50 per barrel in calculating budgets for fiscal year 2009, undoubtedly below existing market rates.

In reality, GCC governments need every opportunity to increase spending in order to overcome problems associated with the financial crisis. Ostensibly, governments have no choice but to invest rising oil revenues on infrastructure projects such as roads, airport expansion and utilities to offset demand.

As a rule, public sector expenditures serve to encourage private sector investors to further spend in the economy. Thus, steady spending by both the public and private sectors allows for higher demand, hence adding to the inflationary environment.

The forecast calls for oil prices closing above $80 per barrel by yearend and still higher in 2010 due to growing demand, providing seeds for inflationary pressures. Clearly, inflation is a force to be reckoned with in GCC economies for the foreseeable future.

The writer is a Member of Parliament in Bahrain.