‘GCC states must trim spend to tame inflation’


GCC can enter a new phase of policy formulation that includes demand management, which it said, suggests a larger share of its oil surplus being kept outside the region. “However unpalatable and seemingly unlikely” demand management is required as a second step to contain inflation in the GCC region, Citigroup said.

It said de-pegging should address supply side factors that are feeding inflation in the Gulf, but tougher steps are also required to contain domestic demand.

“We expect individual currency baskets rather than a unified response. Saudi Arabia and the UAE are likely to take the lead in a Kuwaiti-style currency regime, with an initial revaluation of 4% to 5%.

Citigroup said with large hydrocarbon reserves in the region and the history of free capital flows, policymakers realise that foreign interest in the GCC is here to stay, which suggests that speculative inflows need to be managed.

“In our view, it is highly unlikely that the currency adjustment will be large (say, above 10%) since these countries are inherently conservative. Also, the costs of revaluing are significant and are correlated with the magnitude of the adjustment.

We therefore believe a currency adjustment would be in the range of 4% to 5%, which suggests to us that revaluation alone will not bring down inflation in the GCC.

We believe the demand-side factors have not been given sufficient attention. The commonly held view is that increasing housing and office units to fight inflation is only part of the picture. If demand pressures continue to grow as they have, even increasing supply may not necessarily ease rental increases,” it said.

According to the report, there are two steps for controlling inflation in the GCC region. The first is to revalue the currency to sever the inflation pass-through from a weak dollar and to help expatriate workers.

The second step is to control demand pressures, which is unpalatable and would take time to have an effect.

“In our view, revaluing the currency should give the authorities sufficient time to put more fundamental demand management policies into place. More specifically, the authorities need to tackle both private demand and government spending,” Citigroup said.

Concern with growth in private demand is already being reflected in the manner in which the GCC’s central banks handled the recent Fed interest rate cuts, it said.

The Fed interest rate cut on September 18 was only followed by Kuwait, Qatar and partially by the UAE. Kuwait only reduced its repo rate, but kept its benchmark discount rate unchanged, while Qatar cut its central bank deposit rate, but kept its benchmark rate intact.

“We believe this selective pass-through was designed to allow the interbank market to become more liquid, but also to ensure that banks do not lower lending rates. In effect, this has the dual benefit of discouraging speculators by increasing the carry cost, while signalling that banks should not reduce lending rates and increase credit growth.

“To our knowledge, the GCC governments have not announced any plans to contain government spending. However, as oil prices remain at record highs, we believe this will increase domestic pressure to increase spending,” Citigroup Global Markets said.

If these governments are serious about curbing domestic demand – either directly in terms of government consumption or government investment that crowds-in private investment – they will have to contain fiscal spending in 2008, in our view.

“From the trajectory of fiscal spending in the past few years, this would be particularly difficult for Qatar and the UAE, but would also be a challenge for Kuwait and Saudi Arabia,” Citigroup Global Markets’ analysis said.




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