Liquidity has been good for investors, helping lift asset prices especially equity and real estate valuations. It has also pushed up rent and the cost of living. While inflation has helped the rich to grow richer, the working class and the lower middle class are paying a heavy price for the macro economic shift taking place in the country.

Currently, the country does not have a broad-based consumer price index (CPI) that tracks the price movements of essential goods and services. In the absence of a regularly updated consumer price index, the inflation rate is more or less an approximation or at best a number based on money supply (M3) that does not clearly reflect the increase in retail prices.

“We do not have a comprehensive consumer price index in the country, thus it is difficult to say if the country has a high inflation rate. However, going by the price trends, with the exception of rentals, prices are comparable with other parts of the world,”said Hatem Jerad, head of ABN AMRO's Treasury Advisory Group.

The federal Ministry of Economy and Planning produces a yearly index. According to the ministry statistics, inflation in the UAE rose from 3.1 per cent to 4.7 per cent last year. The figure looks quite unrealistic in the context of more than 20 to 40 per cent increase in the rents and over 20 per cent increases in the prices of essential products and services including fuel, cooking gas, school fees and food items. 

As for the asset price inflation, the excess liquidity from growing oil revenues and reverse investment flows are compounding the issue. “Unfortunately the commonly used policy tool of sterilising foreign exchange inflows through short term debt instruments to mop up excess liquidity is not currently available in the UAE's financial system,” said an economist with a local bank.

The usual monetary policy option of interest rate variations look ineffective. “Firstly, UAE follows the US interest rates because of the currency peg. Secondly, the impact of liquidity is so overwhelming that interest rates alone can't control the inflationary pressure, and more importantly, an unreasonable hike in rates will hurt the current economic boom,” an economist said.

While the ballooning liquidity is just one side of the story, the inflationary pressures have been compounded by the weakening dollar, which has increased the cost of imports.

The common factors all attribute to a hike in domestic inflation are increase in the price of imported goods, depreciation of dollar against major currencies particularly the euro, and increase in liquidity. “Depreciation of dollar has had a major impact on the purchasing power parity of the UAE dirham against other currencies because of its direct peg against the dollar, said an economist with a multinational bank.

Many economists say that a broad based solution could be revaluation of dirham against dollar. The peg has worked well for the country for the past two decades. In the context of  depreciation of dollar against all major currencies around the world it is hotly debated that the dirham could be revalued against dollar. Some even argue in favour of floating peg against a basket of currencies or even a full float of dirham.

Although a revaluation of the currency looks possible, economists and forex experts believe that abandoning of peg at this stage can be more harmful to the country's interests. “The dollar peg has worked perfectly well for the country over the past two decades. In addition, one should not forget that the country's main export item (oil) is priced in dollar and huge portion of overseas assets of UAE investors and government are dollar denominated. Thus it is in nobody's interest to tinker with the peg,” Jerad said.

Price, rent control:  scope for govt action

BY A STAFF REPORTER

DUBAI — The Federal Government has warned traders of serious actions if they increased the prices unreasonably. The Federal Cabinet has also authorised the ministry of Economy and Planning  to take all measures to monitor prices of goods and services and ensure that no increases are effected.

The UAE has all along followed a strict open-market policy, which allows the market forces, namely, supply and demand to determine the prices. Any intervention in the market to control prices would amount to tampering with free market economy model.

“More than intervening on the price side, the governments efforts can be in positively impacting the supply side. Prices could be checked if the import costs are priced in dollar or effectively hedged to protect the cost hike against dollar depreciation,” said a forex dealer.

Recently Abu Dhabi announced the formation of a joint team to evaluate bulk buying of commodities to guarantee steady prices and protect consumer interests. At a meeting  convened by the Abu Dhabi National Foodstuff Company (Foodco) and attended by senior representatives of the Abu Dhabi Planning and Economy Department, Abu Dhabi Investment Company (ADIC) and Cooperative Societies, it was decided to synergise the import of food products to maintain the prices.

Apart from the increase in the prices of essential goods, the main source of inflation in the UAE is rising rents. The inelastic supply of dwelling units in relation to their demand has affected the price (rent) of existing units. There has been a big increase in demand as a result of the expanding population, especially in Dubai. In the case of housing, the government can intervene in the market both in terms of rent control as well as through the supply side intervention.

The current real estate boom in the country is happening only at the upper end of the market. The asset price inflation has pushed up the property prices. The joint impact of high liquidity and speculation has driven up the property market. While more investments are being pumped into the upper segment where the margins are high, there has been hardly any investments in increasing the low cost accommodation.