Dissecting Inflation (page 1 of 4)

Why does inflation matter?
High levels of inflation are negative for economies for a number of reasons. Strong inflation levels are detrimental as they lead to distortions in the economy and give confusing price signals to producers. For individuals on fixed incomes, the rise in prices increases the cost of living, eroding purchasing power. Furthermore, for investors it erodes the value of saving, while effectively reducing the real rate of borrowing for debtors. Meanwhile, if inflation is higher than the level in comparative countries, export competitiveness of goods and services is lost, assuming no compensatory currency adjustment.

With regards to the GCC countries, high inflation levels hamper the diversification of their economies due to difficulties in attracting foreign direct investment. For instance, the higher inflation level is increasing the cost of living in Dubai. In its Cost of Living Survey, Mercer Human Resources Consulting place Dubai as the 25th most expensive city in the world in 2006, out of 144 cities ranked; Dubai's ranking jumped from 73rd position in 2005. Areas of diversification, such as tourism and financial services are becoming less competitive. Indeed, there are indications that the cost of living has resulted in a number of smaller companies looking to move away from Dubai to cheaper locations in the Middle East. Furthermore, a number of expatriates leaving the emirate have highlighted increasing costs as one of the factors behind their decision. The IMF noted in 2006 that inflation remained one of the largest challenges for the UAE economy. However, it has to be noted that FDI into the UAE remains strong, reaching USD 19bn in 2005, suggesting the UAE remains competitive, at least for now.

Measuring true inflation levels
There has been some concern that the CPI data does not adequately measure actual inflation levels in the GCC economies. For example, in its latest article IV consultation report on the UAE (released in July 2006), the IMF indicated shortcomings in the methodology used to compile CPI data, including outdated weightings, lack of imputations for missing data and different reference periods. Although the IMF estimated that inflation increased by 8% in 2005 (compared to the government figure of 6.0%), it highlighted the risk of inflation being even higher. Indeed, in June, at the release of an IMF publication in Abu Dhabi, even the UAE central bank governor Sultan Nasser al-Suwaidi indicated the authorities are not entirely sure what the current level of inflation is.

As a result, we conducted a survey to measure price rises in Jordan, Bahrain Oman, Qatar, and UAE for Standard Chartered Bank employees. We had two main aims for the survey: 1) to get data on key components of CPI, such as price changes in rent, education and weekly shopping baskets; and 2) to understand the main drivers of inflation in the different countries. Although we did not conduct an official survey in Saudi Arabia, a phone survey was conducted to gain anecdotal evidence. We had the strongest level of responses for UAE, which we believe are statistically significant.