Is inflation about to surge in the Oil States?

Overheating is the normal accompaniment to rapid economic growth. That the Oil States are booming is not in any doubt. Standard Chartered Bank forecasts GDP growth of 8% in the UAE this year and as high as 13% in Qatar.

Already UAE contractors are complaining of wild increases in building material costs; steel doubling in price, concrete prices up substantially. What is happening is that a huge number of new development projects are being built at the same time, and that means building materials now have to travel from further and further away.

Of course, the present recession in some key European markets is helping to limit building price inflation, but that is now countered by the rise in the value of the euro against the US dollar, the effective currency of the Oil States. Indeed, the collapse of the US dollar is forcing up the cost of all European imports, from Mercedes to power plants.

Now whether the inflation of building costs finds its way into consumer price inflation is another thing. The most immediate impact will be in squeezing developer's margins and perhaps resulting in the shelving of some private sector projects; larger government projects are likely to have forward-bought key building materials and will be less affected.

Another possibility is that building cost inflation will be past on to consumers through higher property prices and rental costs. Or we could see a mixture of the two scenarios.

In countries such as Kuwait and Saudi Arabia, where real estate has doubled in price in the past two years, developers may have a big enough profit margin to absorb building cost inflation.

However, given the Oil States reliance on imports from Europe then perhaps we should also be more concerned about the fall of the US dollar than sometimes appears to be the case. This would be particularly true if, as HSBC has suggested, the US dollar may have another 20% to fall against the euro.

Inflation is not something that the Oil States have had much cause to worry about in recent years. Over the past decade or more inflation has been very subdued, and just something to be included in annual forecasting. That happy situation now looks about to change as this extreme hazard to corporate profitability has been let out of the bag.

Look at this from another angle. A monetarist would note that the Oil States have seen money supply expand massively due to high oil revenues, and that excess money meeting a restricted supply of goods and services means inflation.

Whether you look at the theoretical or the practical side, the news on the inflation outlook is not good, and business planners will have to adjust their thinking accordingly. One more thought: the rebuilding of Iraq is likely to add considerably to these inflationary pressures.