Weak GCC fiscal policy blamed for inflation

A surge in prices coupled with an economic boom has led to high inflation in the six-nation Gulf Co-operation Council (GCC) and the problem has been compounded by weak GCC fiscal policies, according to a semi-official Gulf study.

Despite their intensified drive to deal with inflation, GCC states do not possess sufficient fiscal policy tools to tackle the problem because of the peg between their currencies and the US dollar, said the study by the Dammam-based Federation of GCC Chambers of Commerce and Industry.

As a result of this peg, the six members had been forced to match the US Fed in cutting interest rates seven times over the past year although they should normally raise rates to stem liquidity and curb inflation, it said.

The situation was aggravated by persistent overspending by GCC governments because of a sharp increase in their oil revenues.

"Inflation in the GCC was first caused by a rapid growth in the population, strong demand, supply bottlenecks and the accumulation of massive current account surpluses… but the weak fiscal policies and lack of monetary flexibility in member states have led to increased inflationary pressures in the region," the study said.

Except for the Kuwaiti dinar, which is linked to a basket of currencies, the currencies of the other GCC members are pegged to the dollar, which had sharply declined over the past year before it recovered in the past few weeks.

The peg has been blamed for a sharp rise in the bill of the GCC's imports from non-US markets while it has also forced them to copy the Federal Reserve in cutting rates although the US move was intended to spur the slackening economy.

Experts believe such cuts in the GCC interest rates and a sharp rise in public and private investments had largely boosted liquidity and exacerbated inflation.

"The GCC fiscal policy has remained tied to the dollar peg and this has left member states with no room for manoeuvering. As a result, the role of the GCC central banks has remained confined to issuing certificates of deposits or other limited fiscal tools to tackle the worsening money supply problem," the study said. "But such a policy has proved futile as money supply has continued to increase and is expected to grow by 17.4 per cent by the end of 2008."

Citing forecasts by the International Monetary Fund, the study said Qatar, Bahrain and the UAE had been the main victims of soaring money supply, which is expected to grow by 22.2 per cent, 21.8 and 18.7 per cent respectively.

It also quoted IMF data as showing the surge in oil prices would push the GCC's combined current account surplus to a record high of $332 billion (Dh1.2 trillion) in 2008 compared with around $215bn in 2007.

It said the surge would sharply increase the GCC foreign assets, which is now estimated at $2trn.

In a recent working paper, IMF financial analysts said soaring rents and food prices, high public spending, the dollar peg and other factors could have been the cause of inflation but it urged GCC nations to study the real reasons.

Despite repeated IMF calls on the GCC to cut expenditure, most members have pursued an expansionary budget policy, tempted by a sharp rise in their income.

Official figures showed the GCC overshot budgeted spending by between 10 and 20 per cent last year but the assumed surplus emerged far higher at the end of the year because the growth in the income outpaced that in spending. The projected budget surplus of around $33bn shot up to nearly $110bn at the end of 2007, half of which was recorded in Saudi Arabia.

The balance was slightly lower than the 2007 surplus of around $121bn.

While they were projected at nearly $187bn in 2007, actual GCC revenues nearly doubled to around $380bn, including about $330bn in crude exports.

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