Most governments would happily have Qatar’s problems. How to exploit a bumper current account surplus, a red-hot construction sector and a stable banking sector. However, behind these hyper-realities lies a more complex truth.
To a large extent, Qatar’s current fiscal and monetary policies are not equipped to deal with the rigours of external shocks hitting the economy.
Qatar, like her other Gulf neighbours, has limited independence to set its monetary policy — due to the Qatari riyal’s peg to the dollar — to combat rising inflation. Historically, for these states, fiscal policy has been shouldered with the responsibility of achieving internal and external stability.
Thus, when an economy shows signs of overheating, it can be controlled with a flexible fiscal policy via, say, the restraining of further increases in current expenditure to control aggregate demand. In fact, in its latest Article IV report on Qatar, the IMF has made a similar suggestion of fiscal restraint along with enhancing the central bank’s liquidity absorption capacity.
But, in recent research, I argued that with the decision to host the Fifa World Cup in 2022, Qatar has lost — to a large extent — the flexibility to manoeuvre its fiscal policy for domestic needs. This is because of the very large amount of fiscal spending that needs to be set aside to finance the required infrastructure to host the tournament. A recent estimate by Deloitte suggests that Qatar plans to invest over $200 billion (Dh735 billion) on World Cup-related construction projects.
To put the figures another way, as already pointed out by Sean Gregory in Time magazine, this represents $100,000 spending per capita for Qatar, compared to $350 per capita for the 2014 Winter Olympics in Russia, $73 per capita for the 2014 Fifa World Cup in Brazil and $54 per capita for the 2010 Fifa World Cup in South Africa. Hence, Qatar will spend 1,852 times more per capita to stage the same event that South Africa did.
Even if one assumes that Qatar is building its infrastructure from scratch, these figures are staggering for a small country like Qatar, whose estimated nominal non-oil GDP in 2012 stood at around $80 billion. Therefore, the non-oil sector is at a greater risk of overheating and rising inflation.
The upshot is that Qatar’s fiscal policy is now on autopilot to follow an expansionary fiscal stance over the next decade. The government’s commitment to finance an ambitious infrastructure target and the resulting loss of discretionary power in fiscal policy implies that it will not be able to use a ‘counter-cyclical’ fiscal policy in the environment of an overheated economy.
This presents a unique challenge for policymakers. On the one hand, its monetary policy is constrained by the fixed dollar peg; on the other hand, its fiscal policy is now much less flexible and may be unable to adjust its spending in response to changes in the economic environment. The loss of both fiscal and monetary policy tools has exposed the economy to the vagaries of internal and external shocks.
It is at this crucial moment that Qatar needs to reconsider the riyal–dollar fixed peg to attain monetary policy independence that is oriented towards purely domestic goals. A pro-active monetary policy is also a necessary condition to offset any unwanted effects of an expansionary fiscal policy.
Moreover, financial deepening and greater access to financial services have increased the relevance of monetary policy for non-oil economic activity in Qatar. A need, therefore, has arisen for credible monetary plans and coordination strategies to ensure an optimal fiscal–monetary mix that is consistent with growth, inflation and financial stability.
The conventional rhetoric, which states that since oil is priced in dollars, pegging the currencies of oil-exporting countries would help reduce the volatility of oil revenues. This logic, however, is fatally flawed, since large swings in the dollar price of oil are automatically transmitted into large swings in government’s oil export revenues.
Recent research has emphasised that the right way to deal with dollar-induced volatility is to allow the revenue stream from oil to rise and fall with the price of oil so that revenue from oil exports in the oil-exporting economy’s own currency becomes less volatile.
By allowing the local currency to appreciate (or depreciate) when oil price is high (or low), the volatility of local currency revenues from oil is minimised. Under this arrangement, the currencies of the Gulf states would have appreciated during the oil boom of 2003–08, helping central banks to partially deal with rising imported inflation and to preserve the external purchasing power of local wages.
Fixed exchange rate systems are dangerous because they may deliver ‘micro’ gains (e.g., firms do not need to worry about exchange rate risks) at the risk of ‘macro’ costs (e.g., inflationary pressure). The Gulf states’ decades-long peg to the dollar has created a ‘Gordian Knot’ in the thinking among policymakers in the Gulf Arab states, which now requires a bold stroke and fresh thinking to untangle this knot.
As Victor Hugo once said, “You can resist an invading army; you cannot resist an idea whose time has come.” Today, de-pegging is such an idea for Qatar and her Gulf neighbours.
— The writer is a former economist at Qatar Central Bank. The views expressed are personal.