How Muscat can tackle inflation

31 July 2008
Despite inflation reaching a record high in May, Oman has yet to act to bring it under control. Christopher Sell reports on how it could deal with the problem.

As Oman’s inflation reached a high of 13.2 per cent in May, questions were being asked about how the sultanate could counter the adverse impact of higher prices.

Figures from the National Economy Ministry show that food, beverage and tobacco prices rose by 22.9 per cent in the year to the end of May, with rents rising by 16.6 per cent over the same period.

The impact of inflation in the short term will be to hamper the construction boom and present Oman as a less attractive option for expatriate staff to relocate to. However, Muscat is yet to act.

Dollar peg

Like other Gulf states, Oman’s currency is pegged to the dollar, which has lost 40 per cent of its value over the past seven years.

“What we are seeing in Oman and the UAE, for example, is the impact of imported inflation and global food price inflation,” says Mary Nicola, economist at Standard Chartered Bank in Dubai.

“Inflation is rising in the GCC, whether you are looking at Oman or Saudi Arabia. They are all used to very low inflation numbers, and now they are dealing with [high] inflation rates.”

Nicola says currency reform is the best option for Oman. “I do not see subsidies as a key way to get to the core of the problem,” she says. “That acts like a band aid, but it is not a cure.

“I think currency reform would be advisable at this time. We have long discussed how currency reform would mitigate the pressure, especially as inflation is imported.”

One measure being considered by the sultanate is to increase salaries. It is an approach that is also being considered in Saudi Arabia, which reported an inflation high of 10.4 per cent in May.

In December 2007, state oil giant Saudi Aramco announced it would increase salaries by 15-40 per cent in a bid to meet rising living costs.

But this approach is too short-termist. Raising salaries to counter inflation will exacerbate the problem, as wage rises will help to keep prices high. Direct price controls are a better way to deal with inflation.

“While Oman does not have the same surpluses as other states, I think as a short-term measure until next year it should see how Saudi Arabia has managed to contain and manage inflation via direct price controls,” says Mushtaq Kahn, an economist at Citigroup in the UK.

Saudi Arabia cut some import duties in April, and Kahn says Oman would do well to observe how effective the policy is.

“They [the Omani government] need to monitor Saudi Arabi’s progress and see whether it brings down inflation,” says Khan. “If yes, then it is something Oman can adopt.”

However, Oman’s economic situation is not viewed negatively by everyone. “It is troubling, but it is imperative to place it in context,” says Simon Williams, an economist with HSBC in Dubai.

“It is taking place during a time of rapid economic growth. It is very much being driven by external developments, especially rising food prices. While much will depend on the developments within the global commodity market over the next 12 months, I believe that Omani inflation is close to its peak. However, it could be some time before we see it decline.”

“I do not think the trajectory over the past seven months - where rates of 2-3 per cent have risen to double digits - is going to continue at the same pace,” agrees Ahmed. “I see it peaking out. Oman’s case might be different though.”

Currency reform

This view is contested. “I do not think that will be the case,” says Nicola. “Global food prices are on the rise. If there is no currency reform in place, if anything we will see inflation rising. Look at Saudi Arabia, which is used to 4 per cent and it is now 10.5 per cent.

“In general it [currency reform] is a political decision - it depends how the US economy plays out. If that eases then we might see some change, but as of now the political pressure is on to stay with the dollar - especially as the US economy is falling into recession.”

There is a trade-off between growth and inflation, and it is one with which the sultanate has to come to terms. Oman has made it clear it is not interested in monetary union by opting out of the single currency.

Lacking the hydrocarbons wealth of other GCC states, and with a young population and limited oil and gas reserves, Muscat is conscious of the need to diversify its economy.

Possibly for this reason, the Omani economy remains in a state of flux, with industry figures struggling to agree on the approach it should take in the coming months.

“I think the hesitation that Oman has is that its problems are different to the rest of the GCC,” says Kahn.

“It did not want to have to follow the other countries’ choices. It is more concerned that its non-oil sector and real estate continues to grow.”

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