Should the UAE heed IMF advice on inflation?

The IMF annual report on the UAE economy has warned that inflation is too high at eight per cent, and that the UAE economy is operating above its capacity.

Its recommendation is that the government should tighten fiscal policy to contain inflation, and 'strengthen coordination among capital market authorities to bring in discipline in the stock market and to help cut the banks' exposure to real estate and equities'.

Yet we know from the experience of the Asian Financial Crisis among other economic episodes that the IMF's tough medicine can carry a pretty nasty aftertaste. It is also open to debate among local economists as to whether the IMF is right in its prescription for the UAE or just reading from its textbook of solutions.

Stock market crash

Surely when a stock market has crashed as in the UAE this year then liquidity has already been withdrawn. For the government to pull cash out of the economy through tighter fiscal policy would risk turning a soft landing into a very hard landing, and shifting an equity asset price correction into real estate.

The IMF is usually one or two steps behind economic reality, and seems to be offering a solution to last year's booming stock market, not an economic policy for dealing with this year's crash.

Likewise a sudden reduction of bank exposure to lending to real estate and equities would probably have a pretty disastrous impact. Namely a runaway economic expansion would be brought to a sudden halt rather than slowing naturally under economic forces of supply and demand.

Soft landing

Perhaps inflation is the less painful medicine, particularly for a country with abundant liquidity from high oil prices. Violent lurches in economic policy do more harm than good, and are only accepted by countries that have no other choice but to satisfy the IMF's stringent loan requirements.

In the case of the UAE the huge real estate construction projects will eventually deliver more than enough housing to depress rentals which are the prime source of local inflation. Indeed, imposing some sort of fiscal discipline to slowdown construction could actually undermine the supply of property needed to contain inflation.

For the oil economies of the Gulf are enjoying a once in a generation economic boom, and are now investing their cash into infrastructure for the future. Thus when times are less good there will still be something to fall back on, and this carries a far higher economic imperative than keeping inflation on target.