Understand GCC Inflation

The persistence rise in consumer price inflation in the six GCC economies has attracted a lot of attention over the past several years. Aside from the global rise in food and energy prcies, strong domestic credit growth (as well as loose money supply) and the prolonged dollar peg have come out as key factors behind GCC’s recent inflation dynamics. Consequently, many (including former Fed chairman Alan Greenspan) have called for moving away from the dollar peg as one of the measures to contain inflation in GCC region.

In order to stimulate an intellectual discussion on the various ways in which the inflation can be contained, below I present the breakdown of sources of CPI inflation for four major GCC economies: Kuwait, Qatar, Saudi Arabia, and UAE (source: Gulf currencies: Change needed and likely, Gerard Lyons and Marios Maratheftis (2007), Standard Chartered Bank).

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As can be seen, except Kuwait, the bulk of the inflation in three remaining GCC states is dominated by one item. Thus for Qatar and UAE, “rent- fuel-energy” inflation contributes most than other items, while for Saudi Arabia, the “food inflation” dominates. Knowledge of itemized inflation is important since one can (roughly) categorize them in terms of tradable or non-tradable inflation, which can easily be analyzed in light of exchange rate movements.

The fact that bulk of Saudi Arabia’s inflation is driven mainly by food inflation (i.e. tradable inflation) warrants immediate elimination of the dollar peg in favor of a more flexible exchange rate system. Thus even though food prices in Saudi Arabia were higher due to higher global commodity price, costs of importing food (say rice from India) would have been lower had the Saudi riyal allowed to appreciate in line with its recent economic boom.

By contrast, higher rent component in Qatar and UAE may indicate that the role of exchange rate is limited since housing is primarily a non-tradable good. Further, higher rent is observed due to domestic supply bottlenecks (i.e. lack of residential units) and/or strong demand condition (i.e. increase in population), and therefore revaluation of domestic currency would unlikely to improve the situation. I would like to see the merit of this argument from our respected RGE audience. Aside from making import of construction materials cheaper, in what ways the much-needed currency revaluation can deal with the “rent inflation”, particularly in Qatar and UAE?

The rather democratic nature of Kuwait’s CPI inflation backs up the move by Central Bank of Kuwait to restore the dinar basket peg in May 2007. Although, since then the dinar has appreciated by around 5-7 percent against the US dollar, inflation has remained strong and now stands above the 10 percent mark. This clearly indicates that a mere (fixed?) basket peg is not sufficient and broad monetary and fiscal measures are needed to deal with inflation.

In fact, a textbook advice to fight inflation would be to tighten money supply and restrain fiscal growth, while many would agree that “controlling inflation” but not “economic diversification” should be the priority of GCC policymakers. That said, meaningful economic diversification can still be pursued by undertaking sequential investments in strategic key areas while simultaneously keeping inflation under control. Development that risks long-run growth is cosmetic and ain’t nice.