Oil prices propel GCC inflation surges

It is not without some irony that high oil prices are to blame for mounting inflation rates in the region, alongside local currencies that are pegged to the US dollar at a time of falling interest rates.

High oil prices are fuelling domestic investment and global business is flocking to the region putting further pressure on the existing supply of accommodation and other infrastructure.

This week’s announcement that the Financial Times of London is to start publishing a Middle East edition with editorial staff based in Abu Dhabi is perhaps indicative of this trend. And if the venerable FT has decided to set up in the region then many more will follow.

Business influx

There is already a mounting exodus of the best and brightest of the financial world from the seemingly doomed capitals of global finance, London and New York, as the economic crisis bites and companies let their staff go by the thousand. Dubai, which has recently replaced Bahrain as the region’s financial capital is the favourite destination.

In Saudi Arabia the government has responded to inflation with cost of living allowances, welfare payments, tighter bank lending, subsidies and a reduction in import taxes.

But the government remains resolutely opposed to a revaluation of the local currency or a move to a basket of currencies and abandonment of the peg. Only Kuwait out of all the GCC countries has adopted a currency basket, and this week again adjusted its currency downwards to counter inflation, which will be lower than in any other Gulf State this year.

Unless oil prices ease from their lofty level of almost $120-a-barrel then it is going to get harder and harder for the authorities to tackle inflation. Money supply in Saudi Arabia was growing at an annualized 23% in March as oil revenues sloshed into the local economy.

Rising business costs

The downside for local business is a big hike in operating costs. That is all right for businesses that can pass this increase straight on to their customers. But it is going to reduce profits for the others, particularly sectors like the media in what is a highly competitive market.

Inflation also tends to skew investment into real estate, as people seek hard assets to protect the real value of their money. However, at the same time inflation undermines the economics of real estate projects by inflating construction costs on pre-sold units. So an inflationary boom can also set up an inflationary bust.

Professional economists have tired of advising Gulf governments to abandon the dollar peg and follow Kuwait’s example, and it may be that a further bout of dollar weakness and even higher inflation levels will be required to persuade them that experts can sometimes be right.