Inflation Bahrain and the United Arab Emirates - Essay Example

?Inflation – Bahrain and UAE Introduction Inflation refers to the increase in the level of prices of goods and services in an economy over a time span. This suggests that every unit of currency will be able to purchase lesser amount of good and services. Inflation may occur due to different reasons. Market imperfections like unbendable demand and adjustments in supply can also bring about inflation. Adjustment in supplies without time lag might not be possible even in a competitive economy. This would bring about the need to improve salary levels and their changes in the economy. Apart from economic factors, cultural and political issues also affect inflation rate. The activities of workers’ union might create pressure on the wage rate preventing any downward movement of the same. Therefore production cost will not come down and hence increase in supply is restrained. An increase in supply of money or credit in the economy can make the incidence of inflation strong in an economy. The global financial crisis which resulted from the excess credit and increasing defaulters especially in the housing loan market led to inflationary pressures owing to increasing demand and cost of basic necessities around the world (Nanda). For the Gulf Countries where oil is a key commodity and factor responsible for growth, the rise in oil prices from 2005-2006 led to increase in related products. The increase in oil prices across the world has been occurring at a rate higher than the depreciation of the dollar. The spot price of oil rose by 171.9 percent ($65.66) and achieved the highest point in August 2006 (reaching the peak at $76.01). Depreciation of dollar across a wide spread of currencies took place at 13.8 percent (Oxford Business Group 38-39). The paper attempts to compare two different Gulf Countries, Bahrain and UAE, with respect to the incidence and impact of inflation. Inflation The first outcome of inflation is usually reflected in the purchasing power of money. Hence there is a reduction in the real value of a good. Inflation rate which measures the price inflation has both positive and negative impacts on the economy. On one hand it reduces the real value of wealth in hands and on the other it creates an expectation of inflation in future and leads to a fall in savings and investments. If there is increased activity of accumulation of goods in apprehension that price might rise further, then there might be a crisis of supply of products in the market. If one considers the positive effects it may be reflected in adjustments of nominal interest rates which help in controlling recessions. Seeing from the demand side, low and moderate inflation are caused by demand side changes or alteration in the number of suppliers at times of crisis and increase in money supply. Going by the Keynesian viewpoint, demand-pull inflation is brought about by a rise in private and government expenditure leadings to high demand. This reflects a grot hint he economy since such higher demand and favorable market situation will lead to higher investment and growth. However cost push inflation which is brought about by supply side shock (fall in supply) could be owing to some natural calamities or high prices of inputs. For instance a sudden increase in oil prices might affect the supply side of those products for which oil is used as raw material or input. The built-in inflation is brought about by a wage-price circle where workers try to keep prices up in keeping with the market price and employers in turn pass this labor cost on to the consumers in the form of higher prices. The essential way out from inflation is the monetary policy and central banks resort to high interest rates and slowed money supply growth to control inflation. Keynesian school of economics suggest that demand can be increased during recession and decreased during boom in order to control inflation; this might be brought about by both monetary and fiscal policy adjustments (Ball). Inflation in Bahrain Inflation as not really an issue for Bahrain as it ranged from one to two percent over the last twenty years. The authorities of the nation favored an eventual approach of phasing out of subsidies. This helped them avoid the sudden increases in consumer price index (CPI). (Azzam, 203) During the recent financial crisis which affected the world, Bahrain has been inflicted with inflation with respect to rise in prices of necessity goods. Going by the official data of the government, inflation rate came down to 2.7 percent in June 2009 from 3.5 percent in May, thus reaching the lowest point in last 23 months. This could be enabled by a decline in food prices. (Weekly Market Watch) In June 2008 the annual inflation rate of Bahrain was stable at 3.1 percent in June and on a monthly basis consumer prices increased by 0.95 percent (using 2006 as base year). The latter was caused by increasing in housing and amenities costs (1.5 percent). This was the time of global recessionary phase during which food prices and increasing housing rents across the world influenced the prices of the Gulf region, making them rise. The region known for the largest oil exporter faced a six times increase in prices of oil (from 2002). The people with low wages can feel the strain. According to the CIO, “The housing, water, electricity, gas and other fuels group has seen a rise in prices due to the rising price of home maintenance material prices"(Merzaban). The nation also pegged its exchanged rate to the weak currency dollar and hence faced the impact further. Increased spending capacity arising from rise in oil prices has brought about rise in level of spending by the nationals and the visitors from places like Saudi Arabia, leading to inflationary conditions (inflation increased to 1.7 percent in 2000 as compared to .5 percent in 1999) An amount of BD40 million was designation in order to fight the inflation by allocating BD 50 to every family earning a gross income of BD1500 or below (AL A'ALI). An amount of $1.3 billion annually was allocated for subsidies on fuel and food apart from the central bank raising the reserve requirements to 7 percent (Merzaban). The following table shows the inflation rates from 2000 to 2009 considering year on year growth rate in consumer prices: Table 1: Country 2000 2001 2002 2003 2004 2005 2006 2007 2008 Bahrain 0.5 2 1.5 0.5 -0.2 2.1 2.7 3.5 3.3 (Bahrain Inflation rate (consumers prices)) The table below shows the inflation date (averages for every year instead of being end of year data) over the past two decades: Year Inflation, average consumer price index 1980 3.8 1981 11.4 1982 8.7 1983 3.2 1984 0 1985 -2.4 1986 -2.5 1987 -1.7 1988 0.2 1989 1.2 1990 -0.91 1991 0.899 1992 -0.302 1993 2.599 1994 3.999 1995 3.139 1996 -0.185 1997 4.602 1998 -0.418 1999 -1.259 2000 -0.73 2001 -1.175 2002 -0.496 2003 1.679 2004 2.248 2005 2.618 2006 2.041 2007 3.252 2008 3.533 2009 2.785 2010 2.643 (Bahrain Inflation rate (consumers prices)) Inflation in UAE: The country of United Arab Emirates (UAE) has witnessed high inflation rates with an estimation of consumers’ prices growing at 8 percent in 2005 and 7.7 percent in 2006 as compared to some analysts and experts who estimated it up to 15 percent during the period. The reason behind this inflation could be attributed to the fast rate at which the economy is expanding but the question arises as to whether this rise is healthy since inflation rates have been dissolving the GDP growth rate. However the incidence of inflation on the economy of UAE does not have equal effects everywhere. Housing rents and associated products comprise one third of the index of inflation and growing at 10 percent in 2005, these prices have affected the small business entrepreneurs and the skilled expatriate workforce which contribute to the renting estimates. The problem arose because of a shortage in availability of housing provision and a rise in demand coming from the emigrant population. The UAE nationals and were not affected as they were mostly house owners (Oxford Business Group 38). This explains why all the areas were not equally affected. Another important factor was the increase in oil prices across the world as seen in case of Bahrain. UAE reserves comprise of 98 percent dollar denomination and 2 percent of the same in euros. Monetary authorities are hence deeming it necessary to reorganize the foreign currency weigh distribution in the reserve basket. There are plans to form a common GCC currency on one hand and consideration of keeping a wider range of currencies in he reserves on the other hand can help in resolving the problem of vulnerability. However inflation fell to a large proportion in 2009 from 12.3 percent to 1.5 percent (2008 to 2009) owing to many factors like decline in oil prices, imports and commodities apart from a fall in rentals and cost of housing. Also, “The global crisis led to a decline in global demand for most basic commodities, and lowered prices of construction materials, food and other goods and services” as per a report from UAE (Avila Capital Markets). The following table shows the year on year change (as %) in consumer prices: Country 2000 2001 2002 2003 2004 2005 2006 2007 2008 United Arab Emirates 4 4.5 4.5 2.8 3.2 3.2 10.5 10 14 (UAE Inflation rate (consumers prices)) The following table shows the change in inflation (based on average consumer price index) for the last two decades in UAE: Year Inflation, average consumer prices 1980 10.066 1981 7.946 1982 7.083 1983 1.297 1984 2.433 1985 3.5 1986 5.435 1987 5.498 1988 4.995 1989 2.792 1990 0.604 1991 5.5 1992 4.311 1993 5.227 1994 5.716 1995 4.369 1996 2.978 1997 2.948 1998 1.957 1999 2.095 2000 1.357 2001 2.8 2002 2.918 2003 3.119 2004 5.041 2005 6.195 2006 9.285 2007 11.128 2008 12.258 2009 1.213 2010 1.988 (UAE Inflation rate (consumers prices)) Bahrain and UAE: comparison The factors leading to inflation in both Bahrain and UAE are similar (pegged to weak dollar, rise in oil prices, housing cost, etc). However the increase in prices of Bahrain was low compared to the other nations of Saudi Arabia, UAE and Kuwait where inflation surpassed 10 percent (Merzaban). The following graph will bring out the difference in the trend of inflation rates over the period 2000 to 2009: The years 2006 to 2009 show double digit inflation rates for UAE as compared to the low single digits inflation rates for Bahrain. However each of them experienced an increase in inflation from the previous years. The inflow of expatriates, especially skilled labor force looking for accommodation is higher in UAE compared to Bahrain. While economic growth in UAE was occurring at a fast rate bringing about inflation arising from demand side, Bahrain faced the problem of inflation owing to increased spending which generated demand. Oil contributes to most of the prosperity in the economies of countries like Bahrain and hence the soaring prices of oil have its utmost negative impact in the form of inflation in these nations. While immigrants began to move back tot heir home countries from the prosperous nations like UAE, Bahrain’s low wage earners were negatively affected. Here the case is different from that of UAE where the unskilled labor population is usually supported by their employers in terms of accommodation and food. In case of Bahrain government had to come to the assistance of low wage earners. Unlike this the skilled labor population of UAE was affected more than the unskilled population. Conclusion From the above discussion it is clear that the factor which affected that Gulf Countries were more or less similar. Some of the regions like UAE especially in cities like Dubai and Abu Dhabi were the center for “excess and success” or the so called boom. However the inflationary pressures began to take it away from them as the immigrant workers began to move away to other places (Rao). The economies were growing at the rate of 5 to 7 percent per annum for the quite some time until the problem hit them. The problem was strengthened by the increasing in housing rents and currency being marked to the weak dollar. This was therefore led by the demand pull factors and affected different regions to different extents. for instance in the countries taken for the research, Bahrain and UAE, one finds that the inflation in UAE has been in double figures for quite sometime (2006-2008) after which it came down substantially in 2009. On the other hand, Bahrain did not feel the inflationary pressures to that great an extent apart from the poor wage earners. Apart from monetary aids to help the people in distress some sustainable measures need to be adopted. An independent monetary policy is required by these countries. Pegging their currencies to a number of foreign currencies has increased the problem and hence a call for floating exchange rate is essential apart from a common currency (Lachman). The unprepared ness of the economies in the face of such pressures form inflation reveals the short sightedness of the economies and also shows that economic prosperity at the cost of inflation cannot be sustainable and the Keynesian proposition of increasing demand during recession and decreasing the same during boom might explain it all. References Azzam, Henry T. The Arab World facing the challenge of the new millennium, I.B. Tauris, 2002 Avila Capital Markets, “(Khaleej Times) UAE’s inflation falls substantially in 2009”, 2010, May 4, 2011 from: http://avilacmg.wordpress.com/2010/11/09/khaleej-times-uaes-inflation-falls-substantially-in-2009/ Merzaban, Daliah, Bahrain inflation steady at 3.1% in June, Arabian Business, 2008, May 4, 2011 from: http://www.arabianbusiness.com/bahrain-inflation-steady-at-3-1-in-june-46032.html Weekly Market Watch, Credit Libanais SAL, 2009, issue 215, May 4, 2011 from: http://mediaserver.fxstreet.com/Reports/0b89467b-015e-4bc7-958d-8bad92e8d5c2/31cd2109-9bc9-4a34-b2e9-3971b1a39e52.pdf AL A'ALI, Mohammad, “Cash help for families on way”, Gulf Daily News, 2008, May 4, 2011 from: http://www.gulf-daily-news.com/NewsDetails.aspx?storyid=206785 Nanda, Sushil. “4 most important causes for the rise of inflation in different countries”, Preserve articles, n.d. May 5, 2011 from: http://www.preservearticles.com/201102073972/causes-of-inflation.html  Lachman, Desmond, Gulf Nations should seek to move to floating exchange rate, 2008, FT, May 5, 2011 from: http://www.ft.com/cms/s/0/b5d09e42-4e16-11dd-820e-000077b07658.html#axzz1LPcj3qSp Oxford Business Group (2007) The Report: Abu Dhabi 2007, Oxford Business Group Rao, VS Rama, Soaring inflation even affects Gulf countries, Cite Man Network, May 5, 2011 from: http://www.citeman.com/3763-soaring-inflation-even-affects-gulf-countries/ Bahrain Inflation rate (consumers prices), Index Mundi, 2010, May 5, 2011 from: http://www.indexmundi.com/bahrain/inflation_rate_(consumer_prices).html Ball, R.J. Inflation and the theory of money, Transaction publishers, 2007 UAE Inflation rate (Consumer prices), Index Mundi, 2010, May 5, 2011 from: http://www.indexmundi.com/united_arab_emirates/inflation_rate_(consumer_prices).html Read More