from Follow the Money

The Gulf’s inflationary monetary-fiscal-policy spiral ....

August 3, 2008

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The Gulf has -- by virtue of its peg to the dollar -- entered into an era of "single digit interest rates and double digit inflation." So writes the Global Financial House in its report on the Gulf’s economic outlook:

the region would have to “live with the paradox of single-digit interest rates and high double-digit inflation”, said Ala’a al-Yousuf, Chief Economist at GFH.

Moreover, loose monetary policy is generating pressure to loosen fiscal policy, as it is hard to explain why real wages for government workers are falling when oil revenue is soaring. That too will add to inflationary pressure:

So far, the government response to spiralling inflation has been in the form of higher wages, increased subsidies and other cash incentives, the report said, in the absence of any relief from the currency effect of the dollar peg.

“In our opinion, the GCC is entering a phase of loose monetary-fiscal policy spiral, which, together with a wage-inflation spiral, have trapped the region between two impossible trinities,” said Hany Genena, Senior Economist at GFH.

Government spending is set to rise 25% this year, reaching $300 billion. That is roughly half of the Gulf’s likely oil export revenues, assuming roughly 15 mbd of exports, an average oil price of around $120 for the year and $5 a barrel production costs. And that total leaves out -- I think -- a lot of government sponsored investment projects.

No wonder the region is booming. Monetary and fiscal policies are both wildly expansionary. This will, over time, help to reduce the oil exporters surplus and thus facilitate global adjustment. But it also risks laying the ground for big problems if the price of oil turns down.

Letting the exchange rate adjust up -- and down -- with the price of oil still seems to me to be a better way of managing commodity price volatility.

One thing though is clear: at current oil prices, the small Gulf states are once again fabulously wealthy.

Qatar’s per capita GDP is expected to top $100,000 soon. If Qatar’s GDP was calculated in way that excluded the income of the guest workers who live in Qatar but have no claim on the oil revenue, the per capita GDP of native-born Qataris would be far higher. So too the per capita GDP of the half a million or so residents of Abu Dhabi who get a cut of the emirate’s roughly $100 billion in current oil revenue. I think that works out to something like $200,000 a year in oil revenue per Abu Dhabian.

In a lot of ways, the immense current profits from oil production makes it harder to stop inflation. Everyone knows the money to pay higher salaries is there ...

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