DUBAI - Inflation in the UAE is expected to soar to a record 12 per
cent this year unless immediate steps are taken to revalue the dirham
to tighten monetary policy, warned a leading global financial
management and advisory company.
Predicting that strong capital inflows, extra-loose monetary
policy, weakening fiscal prudence and imported inflation are likely to
drive inflation in the absence of a tight monetary policy. Merrill
Lynch also said currency strengthening should be used as a policy tool
in the fight against inflation.
"Therefore de-pegging and/or revaluation of the currencies will remain under the spotlight in 2008 in the UAE and other GCC
countries. The UAE and Qatar, both recording double-digit inflation
rates and broad-based strong GDP growth, are on our watch-list as we
expect the two GCC
countries to be the first to revalue and re/de-peg from a tumbling dollar."
Consumer Price Index (CPI) inflation in the UAE, one of the highest in the GCC
after Qatar, has been on an upward spiral, reaching 9.2 per cent in
2006, and an estimated 10 per cent in 2007 and 12 per cent in 2008.
In its latest research analysis, Merrill Lynch noted that under the currency pegs, GCC
monetary policy mimics the Fed Funds rate. "However, Fed policies in
dealing with a US recession are not going down well in the GCC
, whose members are aiming to curb inflation. With the Fed making further cuts and the GCC
countries following suit, real rates in the region are likely to slip
further into negative territory, thereby further fuelling fire."
The report warned that with an 80 per cent expatriate population and
mega investment projects, rising living/building costs threaten the
sustainability of UAE's growth model and need to be addressed.
"There are many reasons for high inflation in the UAE, but the currency
peg to the dollar lies at the heart of problem. The domestic economy,
especially the non-oil sector, is already heated up, hitting
supply-side constraints," the report said.
According to
Turker Hamzaoglu, financial investment strategist at Merrill Lynch,
with heated domestic demand in the region, pegs to the sliding dollar
not only import inflation and fuel domestic liquidity but, more
importantly, they also import easing monetary policy as the Fed cuts
rates and GCC
countries follow suit.
"This pushes inflation further. Inflation is likely to stay on an increasing trend in the short-term."
GCC
countries have built up a cumulative current account surplus of some
$730 billion over the past five years. Capital inflows have gained
pace, and the region is awash with cash. Big investment projects are
kick starting one after another. Some supply-side bottlenecks seem
inevitable in the short term, particularly in the housing sector in the
UAE and Qatar.
Inflation in the GCC
,
the report said, increased from 0.3 per cent in 2001 to an estimated
6.3 per cent in 2007, ranging widely from three per cent in Bahrain to
14 per cent in Qatar. "The common trait for all six countries is the
fact that inflation is on the rise. While there is a wide consensus
that higher inflation is a side-effect of the GCC
's rapid and oil-driven economic boom, views differ widely as to pinpointing the source of the region's rising inflation."
Calling for de-pegging and/or revaluation to ease inflationary
pressure, Merrill Lynch said the positive terms of trade shock brought
about by the oil bonanza are the main drivers of GCC
inflation.
"Without
the peg, such terms of trade shock would have led to currency
appreciation, helping to mop up excess liquidity, making home goods
less attractive and easing imported inflation. However, as governments
have been reluctant to revalue and/or de-peg, real adjustment is taking
place via higher inflation."
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