Among the myriad of excuses for the region’s rampaging inflation, the weak dollar has been one of the favourites for GCC central bank governors. With the value of the dollar rising in recent weeks, helping to claw back some of its losses over the past two years, it was inevitable that some market watchers would see this as a panacea for inflation.
But those hoping for any swift reversals of inflation will be disappointed. It is expected to continue hitting highs during the second half of 2008, before stabilising in 2009 and declining slightly in the following year.
The reason is that, despite attempts to simplify the issue down to one of dollar pegs and housing shortages, inflation is becoming a more complex structural issue for the GCC economies. Some inflation is feeding through via the dollar peg, but it is probably less than 2 percentage points of the overall figure.
Expansionary government budgets and booming lending by the banking sector mean that money supply is continuing to push up inflation. Rising land and construction costs are expected to continue putting pressure on real estate prices. Interest rates in the US are also likely to stay low for the next 12 months, preventing the region from being able to soak up excess liquidity with higher interest rates.
The removal of bets on the possible revaluation of GCC currencies has also pushed up local currency lending rates, which will push up corporate borrowing costs, and could feed through to consumer prices.
There is also a risk that expectations about inflation are becoming entrenched. The pay rises which have been granted to government workers around the region this year are likely to have an inflationary effect on the price of goods, and also affect private sector wage negotiations, contributing to a continuing spiral of inflation.
All this means that inflation is likely to remain in double figures or close to them. The strengthening dollar will help to reduce inflation, but it certainly will not cure the problem.