Inflation was the biggest economic story in the Middle East for 2008, before the global financial system almost completely self-destructed. While inflation was a global problem due to a sharp rise in oil and food prices, levels in the Middle East were exceptionally high. The GCC’s average inflation rate was estimated to be 11.5%, according to Global Research. Inflation exerted significant pressure on much of the region’s population and civil unrest occurred from the UAE to Egypt. The causes for these high levels were largely related to the same underlying issues fuelling global inflation, but in the region they were further exasperated by the dollar peg, strong domestic demand and supply bottlenecks, especially in the GCC. Not surprisingly, the debate over the pegging of currencies to the dollar re-ignited, especially in the GCC.
The strong growth in both the GDP and the money supply in the GCC should have been accompanied by a tight monetary policy in which short-term interest rates would have been raised gradually, but because of the dollar peg this could not occur. “Very low interest rates coupled with high growth precipitated speculation and aggressive buying of real estate and financial instruments led to major bubbles in almost all asset classes,” said Ziad Abou Jamra, director of the trading desk at FIDUS. “Add to that the imported inflation that was due to a very weak dollar and high emerging market demand in China and India, and you had all the ingredients for spiraling inflation levels. In addition, this peg forced the Gulf central banks to print dinars, riyals and dirhams with which to buy dollars, and that money printing is inflationary.”
Subsequently, the big debate as to whether the GCC should move away from the dollar peg to a basket of currencies was taken up again. Kuwait was the first country to de-peg but its inflation still remained above 10% for much of 2008. Given this example, the idea of de-pegging from the dollar met much resistance and governments across the region had to look for other solutions. Amjad Ahmad, CEO of Investment and Merchant Banking at NBK Capital, stated that, “Although the dollar peg had some impact on inflation, ultimately it was the local economic realities of huge liquidity amounts, the high demand and small capacity, that were the underlying causes of inflation.”
To combat the effects of high inflation, many governments implemented broad-based wage increases but this risked second-round inflation effects. The IMF issued a warning to regional governments that broad-based wage increases should be avoided as it was only exacerbating the situation. Governments throughout the region were finding that their options in dealing with inflation and its effects were reduced. Tax cuts on food staples, consumption subsidies, price controls, trade restrictions to protect domestic supplies of food, boosting of social safety nets and supply side measures were all attempted yet none of these successfully mitigated rising inflation or its effects. Everything governments in the region have attempted in order to control inflation was ultimately fruitless. Zaid Maalouf, vice-president of MENA Capital, confirmed that, “Inflation is the most challenging problem for central governments and there are not many financial tools that the central banks in the GCC can use as the money markets here are not as well developed as in Europe.”
Inflation in Lebanon
Lebanon 2008’s inflationary trend was especially acute because of the dire political situation for the first six months of the year and the heavy dependence on imports. Estimated to be between 10-11.5%, depending on whose figures are taken, inflation is now at its highest point in 15 years. At the worst point during the political crisis, it was estimated to be at 13%. Jad Chaaban, acting president of the Lebanese Economic Association, noted another major problem in Lebanon that made inflation even worse: oligopolies. “Lebanese markets are very concentrated, so the importers have a tendency to shift prices immediately to consumers because they have the power to do so due to the fact that there is an oligopoly system in Lebanon. This also leads to an asymmetry of transmission, which means that when costs increase the retailer passes it on to the consumer but when those costs go down the prices to the consumer remain static,” he said.
Getting accurate figures for Lebanese inflation levels is a major problem. Chaaban claimed that the government figures are not correct and that there has not been enough of a concerted effort to reduce inflation. “The central bank does not have an active target for inflation so the government responds with measures that are ad hoc. You don’t see inflation as a top priority for the government and this is bad because in an open economy such as Lebanon, inflation is a major issue,” Chaaban said.
However, Jihad Azour, the then-finance minister, said in an interview in Executive’s April issue that attention is being shifted to fine tune inflation figures with efforts being made by the IMF and the Central Bank of Lebanon. Further to this, Azour noted that the government has a good record when it comes to controlling inflation and in 2008 took several measures to control it. “The first measure was to make sure the increase in the oil price was not passed onto the consumers and this has cost the government $1.1-1.2 billon. The government has lost more than $500 million of revenue per year and additional costs of more than $600 million due to the increase in oil prices in terms of deficit or subsidy to Électricité du Liban. In addition the government provided a 60% subsidy to the wheat that it is importing,” he explained. Nonetheless, despite all these various subsidies for much of 2008 inflation was at record levels.
From inflation to deflation?
Record inflation now appears to be confined to the history books due to the effects of the global financial crisis. “This latest crisis reversed all inflationary stimulators. The real estate bubble is popping, equities and other financial instruments are on sale, crude oil prices are dropping, down 63% from their July 2008 peak. In addition, the dollar is strengthening against all major currencies, paving the way for much lower import prices and halting the printing presses of the regions’ central banks. Lower liquidity means lower speculation and lower inflation,” said Abou Jamra. Subsequently, in 2009 inflation will not be a significant issue. In Europe and the US, where the reversal of inflationary stimulators are more severe, there is even worry of deflation. With the huge budget surpluses in the GCC, however, this is not a significant threat to the region. Yet, Abou Jamra warned, “If history is any guide, real estate and stock prices will continue their downward trend in 2009, notwithstanding a short-term rally for the coming three to six months and this will put a brake on the consumers’ purchases. The only offset to lower consumption is government spending by a lot. With crude oil prices at $55, we doubt that they can do that aggressively.”
