Inflation in the GCC countries, already in double digits except in Bahrain, will continue its northward direction unless the region implements effective policy measures to curb surging money supply fuelled by an unprecedented oil boom, economists warned. Brian Coulton, head economist at Fitch Ratings, said rising export earnings had been pushing up GCC foreign reserves as dollar pegged exchange rates were not allowed to appreciate to the extent dictated by the market. “The impact of foreign exchange reserves on the domestic money supply has in many cases not been offset by sterilization operations. This has fuelled domestic credit growth.” He said countries that had kept their currencies artificially low by pegging them to the dollar made the situation worse. “Because their currencies have not been allowed to appreciate, their exports remain cheap. But to buy foreign currency they have to print more money.” Coulton said like other commodity exporting countries, the GCC had been expanding its money supply in order to prevent the price of domestic assets rising. “Where they expand the money supply, that leads to credit growth, which leads through to higher inflation.” Analysts said GCC inflation, at its highest in over 30 years, will rise further as the region's increased oil earnings, predicted to surge 75 percent to $636 billion in 2008, was stoking a relentless price rally. Inflation is already in double digits in Oman, Qatar and the UAE (hovering around 15-16 percent as latest findings show), and over 10 percent in Kuwait and Saudi Arabia, leaving only Bahrain with a more modest inflation rate of around five percent. Gulf-based economists said a further surge in inflation is inevitable as the GCC has limited monetary policy tools at its disposal because its currencies, except Kuwaiti dinar, are pegged to a weakening dollar. The UAE Central Bank said Money supply (M1) increased by AED61.65 billion, up 51.4 percent, to reach AED181.67 billion in the 2007, compared to AED120.02 billion at the end of previous year. Radoslaw Bodys, Merrill Lynch economist, said the GCC countries continued to avoid addressing soaring inflation by abandoning the dollar peg as they expected the greenback to bounce back. According to him, unbridled price escalation is presenting the region a key micro challenge as the oil windfall continues to boost infrastructure spending. They said most GCC currencies were undervalued against the dollar, based on their current-account balances, inflation and costs of goods and services. The UAE dirham is undervalued by 10-15 percent and the Saudi riyal by 25-30 percent, according to a report by Deutsche Bank AG. “The region's increased oil wealth warrants an increase in real exchange rates, which can come either though a revaluation of the nominal exchange rate or higher prices, or a combination of the two. Given the decision to stick with dollar pegs (except Kuwait), higher inflation is inevitable,” Richard Fox, head of Middle East and Africa sovereign ratings at Fitch, was quoted in report by the global rating agency.
