Policymakers in Abu Dhabi have numerous challenges to confront, but inflation is not one of them. The cost of living in the UAE is, essentially, stable.

While other Gulf countries face resurgent inflationary pressures, the UAE consumer price index, held down by the slow pace of economic recovery, shows little sign of movement.

Demand for goods and services has picked up in Saudi Arabia, Oman and Kuwait after the global downturn. But the UAE economy is still feeling the effects of Dubai’s 2009 financial crisis.

Nationwide, economic growth has been so slow that there is excess capacity across most major sectors, and there is little to fuel a major rebound in inflation.

Dramatic drop

Government figures report inflation of just 0.9 per cent for 2010 – a sharp contrast to the boom months of early 2008, when it was running at an annualised rate of 13 per cent.

“The slowdown happened not just in real estate, but in other areas of the economy as well,” says Simon Williams, chief economist for Gulf markets at HSBC Middle East.

While the slump in the real-estate sector and the consequent drop in rents has been key to the low inflation rate, other factors have also come into play. For example, increases in the price of some construction materials have been offset by decreases in the cost of others. The Statistics Centre – Abu Dhabi says the cost of wires, glass, steel and diesel rose by 10-25 per cent in 2010, but prices for concrete, roofing materials and cement declined by 12-30 per cent.

Wages, meanwhile, were “essentially flat”, says Williams. Even in Abu Dhabi, where state spending continues on a large-scale, construction labour costs fell by 10.9 per cent in 2010.

Government-imposed price controls are also helping to keep inflation down. Although global factors are currently acting to fuel inflation, with higher prices for energy and food, the UAE authorities are not passing the full impact of these increases on to domestic consumers. This is particularly important in the case of fuel.

The federal government has had a long-term policy of obliging the country’s major distributors to sell fuel at fixed retail prices, far below international levels. But the increase in global oil prices during recent months means the cost of the subsidy – either in direct spending by the companies or in lost income from potential export sales – has grown to the point where Abu Dhabi National Oil Company says it makes no profit on its fuel sales in Abu Dhabi and the smaller northern emirates.

The oil companies have been pressing for the right to charge retail customers more and, in April 2010, they were allowed to increase prices for the first time since 2005. It had been expected that further rises would be permitted, but in recent weeks, energy industry sources have said they expect additional hikes to be postponed because of the current political tension in the Middle East.

The UAE authorities are reluctant to take any steps that would add to the cost of living pressures for locals, especially when the overall investment and employment climate remains sluggish. In fact, the subsidies programme is being extended to include food. In March, the government announced it would begin subsidising the cost of bread and rice from April to the end of this year. This subsidy will act as a further brake on the consumer price index.

Lower rents in the UAE

Nonetheless, the single most important factor in curbing inflation in the UAE continues to be the falling cost of housing, which accounts for 39 per cent of the basket of goods used to calculate the cost of living. Sales prices and rents have decreased dramatically since the end of 2008.

In Dubai, new supply entering the market is expected to keep prices low in the months ahead. Rents are now about 50 per cent lower than they were in early 2009.

The state of the rental market is helping to shape inflation forecasts for the UAE. “Given the projections for further modest easing in rents across the UAE, we expect inflation to remain contained at 2 per cent on average in 2011,” Shuaa Capital said in its inflation forecast in early January.

The UAE Central Bank agrees that inflation will remain low this year. Its interest rate policy is driven by the need to track rates in the US as the dirham is pegged to the dollar, but the bank is encouraging commercial banks to keep market rates low in order to stimulate a revival in economic activity.

The Washington-based International Monetary Fund is less sure that consumer prices will stagnate. In its April 2011 economic outlook for the Middle East and Central Asia, it forecasts 4.5 per cent inflation in the UAE this year, but it is not clear whether this forecast takes account of state price controls on bread and rice, and renewed reluctance to end fuel subsidies.