Inflation is price of record oil

10 December 2007
Backed by high oil prices, governments across the region have been boosting money supply by pumping huge amounts of investment into their economies. But while that has underpinned the Gulf's booming projects market, it has also added to the region's inflation problem.

Unfortunately, there is little they can do to stop the process. Indeed, as long as inflation does not start running out of control, there is little they should do differently.

Money supply is not the only factor pushing up prices. High levels of bank lending have had a significant impact, and the currency peg to the US dollar is also partly to blame. But while the peg exacerbates the problem, removing it would only partially help.

Lacking the monetary tools available to other governments, the GCC finance ministries are not able to raise interest rates to take some excess cash out of the economy.

But even if the other five members of the GCC follow Kuwait by dropping the dollar peg, the most likely alternative for them is, like Kuwait, to peg their dinars, riyals and dirhams to a basket of currencies dominated by the dollar. Any impact on inflation would therefore be minimal.

There are some small things governments can do, however. The central banks could put pressure on commercial banks to lend less. Governments can offer bonds and other financial instruments to soak up excess liquidity.

But ultimately, these are minor issues. The biggest factor is the continuing high oil price. With crude trading at near-record levels, governments will continue to reap huge windfalls and remain under pressure to spend that money to improve infrastructure, access to utilities, education and more.

That is as it should be. The price the region will have to continue to pay, until the oil price falls, is relatively high inflation.

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