Increased government spending on salaries and subsidies, aimed at alleviating the effects of inflation, may stimulate demand, leading to further price rises, said senior analyst Tristan Cooper, in a research note.
Inflation accelerated to records in all six GCC states during the past year, fueled by higher government spending and a falling dollar, to which most of their currencies are linked.
Federal employees in the UAE were given a 70% salary increase at the beginning of 2008.
“The danger is that governments across the GCC may find it increasingly difficult to limit expenditure growth in the face of rising inflation, thereby locking themselves into higher and higher oil prices in order to balance their budgets,” Cooper said in the note.
Kuwait based its 2008 fiscal year budget on an oil price of $ 58 per barrel, compared with $ 36 in the previous fiscal year, while Saudi Arabia’s 2008 budget assumes a price of $ 45 per barrel versus $ 38 per barrel in 2007.
Inflation averaged 6.3% in the six GCC countries in 2007, versus 0.3% in 2001, Merrill Lynch has said.
Inflation in the UAE rose to a record 9.8% in 2007 from 9.3% in 2006, according to the median estimate of seven economists surveyed by Bloomberg in December.
Consumer prices increased an annual 6.5% in Saudi Arabia, the largest Arab economy, in December. Saudi Arabia on Monday approved a 17-point plan to address the impact of inflation, including a 5% wage increase, continued subsidies and a lowering of tariffs on imported goods.
Kuwait last week said it would increase spending in its new budget by 58%. Dubai said it will raise spending by 31% this year.
“Large increases in current expenditure are of particular concern as they are more difficult to reverse than hikes in capital spending in the event of a potential downturn in revenue,” Cooper said.
While the potential impact of this higher spending on Gulf states’ credit ratings in the short to medium-term is limited, “there could be longer term implications,” he said.
Saudi Arabia’s long-term foreign debt is rated Aa3 by Moody’s, the fourth highest grade, as are that of Oman and Bahrain.
Kuwait, Qatar and Abu Dhabi are rated Aa2, a step higher. The UAE does not currently have a sovereign rating.
The credit ratings of the Gulf’s wealthiest nations are constrained by political risks, the development of domestic institutions and economic dependence on oil and gas, Moody’s said in November last year.
