Catch-22 situation for UAE economy

“We are in a peculiar economic situation where any excessive control on liquidity and credit expansion could result in capital flight. On the other hand, if the expanding liquidity is left on its own, it could result in rising costs and prices,” the official said.

Currently, the UAE Central Bank is exercising only limited policy measures such as variable interest rates (follows the US rates) and the recently introduced five years certificates of deposits (CDs) to curb liquidity.

The UAE economy, the third biggest in the Arab world after Saudi Arabia and Egypt, expanded 7.4 per cent in 2004, according to official figures, and the country's economy minister said in July that the UAE was on course to achieve 12.7 per cent economic growth this year.

The huge flow of wealth from the oil windfall and repatriated Arab investments from the Western markets have fed into the UAE's financial system, resulting in surging asset prices in the form of high premium real estate sector and over valued stock market.

The consumer prices have also been on the rise due to both demand-pull and cost-push factors.

“The rising costs could hurt economic growth of the UAE, which is known for long as a cost effective business hub and a place that offered affordable standard of living. If the inflation is left loose, it will tarnish the cost competitiveness of the UAE. But in the name of inflation control, if excessive curb on domestic investments is applied, investors will opt for other competitive markets in the region,” said Ashok Kumar, CEO of Lotus Knowlwealth, a Mumbai-based investment advisory and research firm.

Last month, the UAE's Central Bank governor said he expected the inflation to be around 6.5 per cent this year. A recent International Monetary Fund study also estimates the growth to be in excess of 10 per cent with the inflation close to 6 per cent. However, a recent survey of economic analysts from the region by Reuters showed the inflation situation as alarming.

“Regardless of the official rates, we are looking at hyper inflation. It is between 20 and 30 per cent this year in the UAE,” a Dubai-based analyst was quoted in the report.

Economists and analysts say, in addition to the fact that demand far exceeding the supply of goods and services resulting in the price hike, there are a number of cost related factors including the fuel price hike and the rising costs of imported items due to weakening of dollar against other leading currencies.

“The UAE's inflationary pressures have also been accelerated by the dollar's persistent weakness in the past three years, which has fed through into a rise in the price of imports as dirham is pegged to dollar,” said an economist with a foreign bank.

Some economists argue that the market should be left to correct itself without any policy intervention. Rising asset prices and costs will level-off the investment flows in the medium term.

“The inflation in the UAE is more due to cyclical factors than structural factors and will correct itself. The fundamentals of the economy are strong with healthy budget surplus and strong balance of payment. However, in the interim, the correction period could be painful for the residents in terms of rising prices and costs,” said an economist.