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The GCC leaders didn't agree to change the GCC's peg to the dollar, but the issue is not dead. Ahmet Akarli of Goldman writes:
Bahrain Foreign Minister Al-Khalifa told Reuters on Sunday that the GCC finance ministers and the central bank governors will gather to discuss "currency revaluations" in the coming few days.... it is clear that the GCC authorities are seriously considering policy alternatives and looking hard into what can be done to bring inflation under control. A currency adjustment is, no doubt, on the agenda.
It certainly should be. The underlying economics haven't changed. Unless the Gulf countries are willing to save all the oil windfall, it is hard to see how their currencies avoid appreciating in real terms. With the GCC currencies depreciating against the world, such "real" appreciation -- a rise in the domestic price level relative to world prices -- can only come from faster inflation.
"There is a fundamental mismatch between the economy at the centre of a currency system [The US] and those elsewhere [The GCC] ... [The Middle East's] ties to a weakening dollar mean rising inflation, and the US is cutting rates just when the Gulf needs a tighter monetary policy. These tensions will get worse"
They already are. Recent data indicates that inflation is picking up across the Gulf.
Saudi inflation is now close to 5% -- and not because of higher domestic oil prices.
Kuwaiti inflation is also rising (it is now 6.2%) despite the dinar's appreciation v the dollar. That shouldn't be a surprise -- relative to the dollar's fall v the euro over the past five years, the dinar hasn't increased by much. And even this year the dinar has depreciated v the euro and the Indian rupee.
Omani inflation is now above 7%.
And Saudi Arabia, Kuwait and Oman are the low-inflation Gulf states.
Qatar's inflation is now close to 14%.
The UAE hasn't released inflation data for 2007 -- but there is little doubt that inflation remains high. UAE inflation is probably comparable to Qatari inflation. Some press reports suggest that prices are rising by close to 20%.
If the Gulf countries were willing to accept that the necessary real appreciation will come from inflation, there current policy mix (a peg to a depreciating dollar, limited monetary sterilization and higher levels of spending and state-led investment) might be consistent. But no Gulf state has been willing to concede that the inevitable consequence of their currency policy mix is inflationary real adjustment.
Indeed, the Saudis are simulantanously trying to hold down a range of prices and increase salaries substantially to offset the impact of existing price rises. That doesn't sound like a viable policy. The UAE is increasing public sector salaries by 70% -- far more than the Saudis. That too is unlikely to curb existing inflationary pressures.
This raises another issue.
Edward Hugh has argued that Russian inflation reflects Russian demographics: too much money is chasing too few people.
I am a bit skeptical of a "demographics" based explanation here. Most oil-exporting economies -- even those with very different demographics than Russia -- are seeing inflation pick up. The Gulf for example isn't short on people. Its population is expanding rapidly, both from a high birth rate and a surge in "imported" labor.
Yet it too has high inflation.
What is the common-denominator then, if it isn't demographics?
A rise in oil prices, a limited willingness to use fiscal policy to sterilize the oil windfall (translation: the oil exporting economies want to spend some of the oil windfall at home), a peg to either the dollar or, in Russia's case, a euro/ dollar basket and limited capacity to use monetary policy to offset a rise in inflation.
UPDATE: The latest data puts Saudi inflation well above 5%. Akarli of Goldman:
"CPI accelerated further to 5.35% in October, from 4.9% in September. .... Inflation is accelerating faster than we had anticipated, due to strong demand side pressures and rising food prices. Accordingly we revise our year-end-2007 inflation forecast to 6.5%, from previous 6%."
Doesn't look the Saudi's current policy mix -- one that combines price controls and salary hikes -- is working.