Bye bye, Dollar

It's been a long few years, here in the GCC. Since 2001, the price of oil has been increasing, after remaining more or less controlled under the $30 level. Inflation levels in the region have been growing, and with the value of the US dollar falling quickly (and with our GCC currencies all linked to the value of the dollar) inflation has been pushed to even higher levels.

Inflation is a normal part of any growing economy. Economy grows, people get richer, demand increases, prices rise. It's as simple as that. However, there are reasonable levels to inflation, and what has been happening in the GCC is far from reasonable.

Have you realized almost everything has seemed to become more expensive? Rent? Land prices? Cars? Imports?

Why? Besides regular inflation, being linked to the value of the dollar means it costs us more to import goods. Pound Sterling was around $1.36 back in 2001, and this month it reached $2.11. Euro was around $0.83 back in 2001, and just yesterday it reached $1.48. Almost double. A similar situation goes with the other major currencies, and the dollar is forecasted to decline even further.

With the steady increase of oil prices after 2001, effectively tripling from around $30 to edging on the border of $100, the Gulf economies grew tremendously. Rapid growth has it's disadvantage, the greatest being inflation, and without increasing the value of the Gulf currencies (through being pegged to the dollar), inflation hits us hard.

So what happens next? Well, Kuwait took the first step a few months ago and dropped the dollar peg in favor of a currency basket (ie, pegged to a mixture of currencies), and the Kuwaiti Dinar has been rising in value since. The rest of the GCC is still dollar-pegged though. In reality, the Kuwaiti Dinar was only forced to peg in late 2003, and was looking for any excuse to de-peg.

Inflation is now causing societal and political issues; imports getting more expensive, workers demanding salary increases, and so on. The next step should come from either the UAE or Saudi, whose economies are under severe pressure to revalue. Bahrain or Oman are hardly likely to effect a decision, as they have shallow markets and have been sheltred from speculative inflows, and will probably follow suit regarding what Saudi/UAE decide. Qatar does have the highest inflation in the GCC, but compared to the other member countries, it has started to diversify it's economy later, and still has an under-developed currency market; also with a higher GDP than it's neighbors, it has a higher tolerance for inflation.

The situation with the UAE is a little off, however. Yesterday, the UAE decided to increase public sector wages by 70%. This stated, it might mean that they are against revaluing their currency, which would probably cause some issues with the other countries that want to revalue.

The GCC Supreme Council meeting is in December, and with the mounting pressure, something has to happen. In September, the decision was made to delay a monetary union between the GCC. However, for a commitment towards a common market and closer economic cooperation, perhaps a semi-mutual agreement needs to be made in terms of the dollar-peg situation, as no country will be able to drop the peg unilaterally without the consent of the other members.

The effects on global markets would not be small, however. The volume of funds under management by the GCC are around $1.5 trillion, and any abrupt shift could disturb the global market, and so such an issue needs to be very carefully addressed (ie, an already weak dollar could take a severe hit, if the market sees a de-peg as a sign that the GCC has turned it's back on the dollar).

Either way, the inflation problem is a very serious issue, and if left unaddressed it could damage the economy, and specifically the construction sector which affects a large part of the economic activity in the region. Realistically though, a currency revaluation is required, but not necessarily enough. A revaluation should be correlated with the size of the adjustment/inflation, which should probably be between 10-20%. However, with the Gulf countries being inherently conservative, it is much more likely that a realistic adjustment would come to around 4-5%. Therefore, other measures need to take place to reduce GCC inflation. However, it will buy the countries some time to formulate other policies controlling this issue.

All said, lets keep our eyes on the GCC Supreme Council meeting in December.