Article on Inflation in the Economist

Found this article on inflation in the Economist. Condition, ie economic condition, fundamentals is more or similar in the Middle East to Malaysia. I support steps taken to remove subsidies on good and services, e.g subsidy on petrol, rice and cooking oil etc. Instead consider compensation payments to low income families to offset their loss of purchasing power.

Definitely I dont like what Govt did to PROTES protester! See the pics of in Malaysiakini. Hey they are highlighting inflation issues!
Inflation plague
Feb 4th 2008
From the Economist Intelligence Unit ViewsWire

Prices are rising in the Middle East


Inflationary pressures are rising in the Middle East and North Africa (MENA) region, partly owing to exogenous factors such as high global commodity prices, but also fuelled by the predominance of currency pegs to the weakening US dollar and to the abundance of oil-related liquidity in the region.

While oil-exporting countries in the region are benefiting in terms of the huge fillip to growth and to their external balances provided by persistently high oil prices, the non oil-exporting countries and countries that import oil-related products despite being oil producers (such as Iran and Syria) have been suffering. Although fuel prices were markedly higher in 2006-07, the full impact of the price rises in many countries was not reflected in inflation data as a result of the widespread practise of subsidising the retail price of "basic essentials" (primarily food and energy) in many MENA countries. This was also the case as global food prices started to rise strongly in the second half of 2007.

Biting the subsidies bullet
The fiscal burden of these subsidies is starting to prove unsustainable, however, and many governments—including Jordan, Syria and Tunisia—have announced their intention to either eliminate or cut subsidies in 2008. The cuts in subsidies will add significantly to inflation in these countries, depending on the extent to which subsidies are cut. In Jordan the government is proposing the complete elimination of subsidies, but has outlined a package of compensatory payments for low-income households. Syria is also considering compensatory payments. Such payments, however, could merely serve to sustain domestic demand and thus price pressure in the economy.

The prices for building materials, such as steel, cement and copper, have also risen strongly over the last couple of years, driven by strong economic growth in Emerging Asia, particularly China, and by the construction boom in the Middle East itself. This has added to inflationary pressures across the region, but especially in the GCC which is trying to develop rapidly the necessary infrastructure to sustain its ambitious economic development plans. The rise in the cost of construction materials has exacerbated the problem of a shortage of housing supply that was already pushing up housing and rental costs in the GCC.

Dollar peg dilemma
Currency pegs are widespread across the region. While many North African countries operate pegs dominated by the euro, the Gulf Co-operation Council (GCC) countries are almost all pegged to the weakening US dollar. This has led to a rise in imported inflation and counter-cyclical interest-rate policies.

There was much debate over the course of 2007 about whether the GCC member states would chose to abandon their pegs to the US dollar given that they were contributing to already rising inflationary pressure. Speculation about a change in the prevailing exchange rate regimes reached fever point in the summer following the decision by the Kuwaiti central bank to drop the dinar's peg to the dollar in favour of a peg to a trade- and investment-weighted basket of currencies (albeit still dominated by the US dollar).

Following the Fed down
Since the summer, there has been additional pressure to either revalue the pegs or depeg altogether as the US Federal Reserve embarked on a sharp loosening of monetary policy conditions through interest rate cuts. This pressure has heightened since the beginning of 2008 with the Fed cutting rates by a total of 125 basis points in two moves in January. To a greater or lesser degree all the GCC countries have followed suit and lowered local interest rates. As a result, real interest rates in all GCC countries are now deeply negative and particularly so in the UAE and Qatar which have the highest current inflation rates. Nearly all the central banks have opted to cut their equivalent of the discount rate while keeping their lending rate on hold. While this will theoretically curtail the expansionary monetary impact of lower interest rates, in reality it will not be very effective as commercial banks in the GCC have little recourse to borrowing from their respective central banks.

Yet more subsidies
In the absence of sophisticated monetary tools, most GCC countries have come up with package of measures designed to either counter the negative impact of rising inflation on incomes or to contain price increases. In the UAE the governments of Abu Dhabi, Dubai and Sharjah announced caps on annual rent rises of 5% (the caps were 7% in 2007 and 15% in 2006), although anecdotal evidence suggests that landlords are more than capable of circumventing these constraints. The UAE government also announced in its 2008 budget that it was giving a 70% pay rise to all public-sector workers (almost all of whom are Emirati nationals). In January 2008 Saudi Arabia announced a swathe of measures designed to contain inflation (and the negative impact of inflation) including subsidising a wide range of fees, awarding a 5% cost-of-living allowance to all state employees and pensioners and boosting social security payments. The Saudi Arabian Monetary Agency (SAMA, the central bank) has also enacted two increases in the commercial banks' reserve requirement. The initial rise in November 2007 was the first time the requirement had been changed in 27 years. (Increasing the reserve requirement is a form of monetary tightening as it reduces liquidity in the banking system as well as the lending base of the commercial banking sector.)

The central bank's lack of flexibility on monetary policy and the absence of sophisticated monetary tools have also made it difficult to manage the avalanche of liquidity generated by record oil earnings. Private sector credit growth has soared, even in traditionally conservative Saudi Arabia where it reached 15% year on year in the third quarter. Rates of around 30% year on year meanwhile have been seen in 2007 in the UAE and Qatar.

With this level of credit growth and rapid population growth (as expatriates flock to the GCC to tap into the burgeoning employment opportunities), domestic demand has soared creating problems with supply, particularly in the real estate sector. There was already a shortage of housing that was pushing up the price or rental cost of housing, even before the recent rise in the global price of building materials (and shortages of supply) and rising wage pressure in the construction sector.

What can be done?
As already highlighted, the monetary policy tools available to MENA governments are constrained by the prevalence of some form of currency peg. One alternative anti-inflation tool that is not apparently being considered, particularly in the GCC, is reining in fiscal expenditure; indeed all the GCC states have pledged to maintain their extensive network of subsidies. The same is true of less solvent countries in North Africa, such as Morocco, who will not risk cutting subsidies for fear of the negative social and political ramifications. Furthermore, the size and scale of ongoing infrastructure projects in the GCC, and to a lesser extent across the region, will necessitate growth in budgetary spending for some time.

In a similar vein, with a focus on social stability, the GCC authorities are upping public-sector wages as part of their policy of ensuring that the oil wealth is distributed amongst the population. In poorer North African and near Eastern countries, wage pressure is not so strong, given relatively high unemployment rates. However, attempts to raise the social security net are likely, given the concern that falling disposable income will be socially and politically destabilising. In Iran, where annual inflation oscillates near to 20%, the government is choosing to hand out much of its windfall oil revenue in populist gestures.

Another possible tool that does not appear to be under consideration—at least at the official level—is a break with the currency pegs. The pegs in the GCC are longstanding and have helped maintain macroeconomic stability and attract investment. It can be argued that as the GCC economies modernise and become more dynamic, the currency pegs seem outdated, but what seems clear, is that the regional central banks are not going to be bullied by commercial and financial sector interests to alter a regime that has served them well in the past.

Supply-side measures could help to dampen the current high prevailing rates of inflation. The GCC authorities have tried such measures, including a cap on cement prices in the UAE to help the construction industry or threatening fines on retailers that overcharge, but these measures are piecemeal and, so far, have not had a noticeable impact. Qatar imposed price controls on wheat-based products, however there is a danger that, if too strictly enforced, these could backfire and lead to shortages.

In summary, it looks as though MENA governments, where they can, are partly choosing to live with higher rates of inflation or are choosing to dampen the impact of rising prices by continuing to subsidise goods or by inflating wages. Although these are by no means the textbook responses to inflationary pressures, it looks as though the authorities might succeed in managing expectations, helped by a less inflationary global environment. Our view is that global growth is set to slow in 2008-09 and that by 2009 global non-oil commodity prices and oil prices (to a lesser extent) will be falling, which should take some of the heat out of the regional economies.