Dollar rates pose challenge to restricting Gulf inflation

It’s clear enough that key policymakers at the global level, most especially the US, believe inflation helps produce economic growth — without actually saying as much.

Very low interest rates in the West are aimed at producing higher prices, which supposedly encourages people to spend sooner rather than later, inducing an improvement in the circular flow of income.

Indeed, they are intended to cushion borrowing and promote consumption at the expense of saving.

Moreover, both phenomena are designed to reduce the real value of the debts that governments have accumulated, especially since the global financial crisis and its associated banking bailouts.

Interest rates are an indirect monetary lever, compared, for instance, to regulatory limits on loan provision by the banks. By dint of dollar pegging, whether officially or informally observed, much of Asia is similarly wedded to the easy money yoke. The Gulf countries individually and collectively form a prime example.

Thus is so much of the world locked into the cheap credit environment that has prevailed before, during and since the calamitous crunch episode centred on 2007-2009, from which we are still emerging.

Indeed, while the US is on the verge of tapering direct monetary stimulus, Japan is ballooning its money supply, and now Europe (in the guise of the European Central Bank), desperate to avoid deflation, is contemplating extraordinary measures of its own.

The policy preference for creating inflation goes so far as to embrace the so-called wealth effect of furnishing the liquidity to drive the stock market and property prices. Yet, inflation of equity prices and housing is inflation just the same, albeit cultivating a feel-good factor for those aboard for the ride.

Inflation issue

The fact that the oil-exporting GCC states are growing faster than the US and other blocs — related to oil prices, demographics and relative development phases — means that the inflation issue regionally is liable to take on not just a chronic but possibly an acute character.

In the past year, and increasingly in recent weeks and months, the feeling has grown that regional circumstances threaten to reprise their venture into bubble territory. UAE bourse indices especially surged in 2013, and realty extended its bounce.

The country’s central bank has been moved to apply guidance to restrain the inflationary forces that might be unleashed, knowing that, beyond certain tolerances, inflation is actually destructive of sustainable growth, by the distortion of price signals and motivation of volatility.

The accompanying graphic shows the basic indicators across a ten-year timeframe. Rapid growth rates were accompanied by an aggregate inflation rate that almost reached double-digits as the last decade progressed.

Both inflation and growth have moderated well since the shock of the crisis period, but now might be unhinged by US-related interest rates that are resolutely restrained near to zero, negative in real (inflation-adjusted) terms. Could the key indicators be driven back to unhealthy levels?

Few complain about a quickening of growth, boosting business and employment, but the accompanying inflation doesn’t go unnoticed, especially when translated by the man and woman in the street as the “cost-of-living”. Some governments may quietly adhere to its utility in technical respects, but tend implicitly to be at odds with average citizens in that regard.

Now that we’ve arguably seen both sides of the financial crisis, it’s interesting to note the analytical “then and now” perspective of an observing organisation such as the Institute for International Finance (IIF), tracking the state of the economy and banking sector among the Gulf states.

Government spending

In its 2008 report on the region, the IIF referred to the upsurge in inflation, attributable to population growth of 4-7 per cent, burgeoning government spending leading to shortages in cement, steel and other construction materials, and sharp currency depreciation (owing to what the association termed the handicap of the dollar peg) entailing higher prices for food, metals and other raw materials. Lax monetary and fiscal policies caused their natural outcome.

The IIF’s assessment of the UAE in the last quarter of 2013 cited the symptoms of recent recovery: improved corporate profitability and market confidence in Dubai’s debt load, a significant rebound in real estate, conspicuously soaring stocks, and lending growth accelerating threefold year over year.

Notably, it worried aloud that “markets could become concerned about the renewed cycle of exuberant risk-taking”, so that “the lessons of the past experience may not have been fully absorbed.”

Having pressed the snooze button on that soft-sounding alarm, we might still detect that the situation has advanced in the intervening months.

Hence, while the economy is on a roll again, it seems legitimate to suggest that sheer momentum has its downside, and there is a danger that the crisis experience was perceived as merely a bump along the way, rather than a serious accident.

A proper wake-up call may well be due, to avoid an even harder collision sometime down the road.