When UAE central bank governor Nasser al-Suwaidi told MEED in December 2007 “we do not think there is a correlation between money supply and inflation”, his words had little impact on his GCC partner, Kuwait, or its central bank.

Acting contrary to Al-Suwaidi’s belief, Kuwait is stemming the supply of cash into the economy, cutting the growth in M3 money supply, the broadest measure of money in the economy, from a peak of 27 per cent in January to 18 per cent in June.

This marks the first significant fall in money supply growth since August 2007, and is a sign that inflation could start to moderate before the end of the year.

“The Central Bank of Kuwait has been the most assertive central bank in the region and the first to take steps in fighting inflation,” says Simon Williams, chief economist for Gulf markets at HSBC.

These include limiting new borrowers to monthly repayments of no more than 40 per cent of their salaries, down from 50 per cent, forbidding private companies from buying and selling residential property in a bid to cool the real estate market, and shifting the Kuwaiti dinar’s currency peg from the dollar to a basket of currencies.

As a result of these measures, money supply growth is now at its lowest level in a year. “Money supply growth has started to slow down and the major factor in that has been the initiatives by the Central Bank of Kuwait to curb lending,” says Mary Nicola, economist at Standard Chartered Bank.

Nicola says the Kuwaiti approach has been one of the most mature in the region. “Kuwait is definitely targeting the cause of inflation rather than just the latest symptom,” she says. “Rent caps and freezing food prices, as has happened in the UAE, is just treating the latest examples of inflation, not addressing the root causes.”

Managing expectations

The differing approaches to tackling inflation can be seen by comparing the latest M3 figures for the two countries. In the UAE, M3 growth was 40 per cent in the first quarter of 2008 – far higher than the Kuwaiti figure.

On the currency side, the dinar has gained 3 per cent against the dollar since the beginning of the year, bringing a total revaluation of 8.86 per cent against the dollar since the decision to depeg the dinar.

Although widely regarded as a positive move to address imported inflation, it is difficult to know exactly what impact it has had on rising prices. However, the early indications are positive.

Food inflation in Kuwait was 11.9 per cent in April, about the same as the overall inflation rate, while elsewhere in the region food inflation is typically higher than overall inflation. In Saudi Arabia, for example, food inflation was 15 per cent in May, while headline inflation was much lower, at 10.4 per cent. This could be indicative of the way the more flexible currency regime is benefiting the Kuwaiti economy when it comes to imported goods such as food.

If the decline in money supply can be sustained over the next quarter, it should help temper inflation expectations, which should in turn keep inflation low.

Standard Chartered, HSBC and the local Global Investment House are all currently forecasting that Kuwait’s inflation for the full year 2008 will be about 7 per cent.

The one area where Kuwait is failing to moderate people’s perceptions of inflation is by granting two pay rises already in 2008. Most recently, parliament passed a bill to give workers in the public and private sector a KD50 ($182) a month pay rise for those earning less than KD1,000.

Kuwaiti Finance Minister Mustapha al-Shamali said at the time that “every time spending increases, it [inflation] rises”.

Nicola says the pay rise will send out signals that the government still expects inflation to keep rising, and it will feed into future wage negotiations.

There is also a disparity between efforts to slow retail bank lending at the same time as the government plans to increase spending in its budget to KD 19bn in 2008/09 from KD 9.7bn in 2007/08, fuelled by the high oil price. “Although monetary policy is tightening, fiscal policy is still expansionary,” says Williams.

However, efforts to tame credit expansion and cool the booming real estate market have yet to force inflation to fall. The most recent figures show that inflation rose to 11.4 per cent in April, from 10.2 per cent in March.

“The moves taken by Kuwait to curb inflation have been the right ones, but there is still more that can be done,” says Faisal Hasan, senior financial analyst at Global Investment House. “For example, Kuwait has depegged from the dollar, but the basket is still dominated by the dollar so there is still imported inflation from the dollar weakness.”

He adds that a sustained weakening in money supply growth will contribute to lower inflation, but is unsure if the most recent figures are the result of government policy, or just a statistical anomaly.

How effective the measures announced by Kuwait will be is difficult to assess, but it is expected that by the end of 2008, the country will have one of the lowest inflation rates in the region.