Inflation 'could make GCC vulnerable'

Dubai: High inflation makes the GCC extremely vulnerable to economic shocks, according to analysts from global consulting firm Booz & Company.

While the GCC region has been flourishing with economic expansion, surging oil revenues and an influx of foreign capital, in the event of a sharp drop in oil prices or a global credit crunch coupled with sustained contagion effects, the Gulf economies could contract very swiftly.

Additionally, inflation is likely to surge due to expansionary policies such as interest rate cuts and liquidity infusions as witnessed by the region in recent weeks.

Given the two extreme possibilities analysts argue that Gulf countries should move towards a more sustainable macroeconomic policy framework that supports continued economic growth while keeping inflation under check.

"The GCC must move from a model characterised by overheated economic growth to one that emphasises on growth through sustainable development beginning with fighting inflation comprehensively," said Rabih Abouchakra, Principal of Booz & Company.

Countries that choose a sustainable development growth model, and manage inflation, typically have an easier time sustaining real GDP growth and can recover far more quickly from contractions.

"Historically, Gulf countries do not have both institutional and policy frameworks on both fiscal and monitory policy front to fight inflation. Now is the time for policymakers in the region to develop strong inflation-fighting and macroeconomic stability systems," said Richard Shediac, a Partner with Booz & Company.

According to analysts from Booz & Company, GCC has been following an overheated growth model charectarised by high nominal GDP growth and a satisfactory level of real GDP growth.

"In the event of an external shock like a sharp drop in oil prices, this economy is vulnerable to nominal GDP growth falling below the inflation level, leading to stagflation," said Shediac.

In these economies attacking low growth by interest rate cuts and injecting of more money into the economy causes inflation to surge.

In the recent weeks most Gulf countries including the UAE resorted to both liquidity infusion and rate cuts.