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It's now official. The UAE inflation rate has crossed the double-digit mark and is moving on a sharp upward trajectory.
Although a number of analysts and prominent local businessmen have said in the past that the country's inflation was in double digits, the only official figure available until last week was the 2006 estimate of 9.3 per cent.
While the Ministry of Economy puts the overall inflation rate for 2007 at 11.1 per cent, the latest figure, for the last quarter of last year, is 14.6 per cent, indicating that the country will continue to face double digit inflation for the year ahead, and there could be no substantial decline for a few years.
Analysts who closely track inflation here believe that the ministry's estimates are realistic. Monica Malik, director of economics at EFG-Hermes, a regional investment bank, said they have increased their inflation forecasts for 2008 to 13.2 per cent and for 2009 to 12.7 per cent. "Housing and rental price increases will continue to be driven by rises in Abu Dhabi; Dubai is expected to see a moderation in rent increases," she said.
The soaring inflation is undercutting the rapid economic growth of the country, which is largely being driven by oil surpluses and foreign direct investment. A wage-price spiral appears inevitable as inflation is becoming increasingly entrenched, and the workforce, largely dominated by foreigners, has started demanding higher pay. This could have serious implications for the real GDP growth in the medium term, as corporate earnings and return on investments are likely to take a beating.
While expansionary spending will continue to exert demand pressure on housing and imported items, two key components of inflation, the volatile international currency dynamics are also likely to fuel rising inflation in the UAE as it has no policy recourse to interest rate or exchange rate adjustments in the context of the dirham's peg against the US dollar.
Trade-off
Although it is becoming increasingly evident that the US would like to talk up the dollar against major international currencies, yet engineer a fall against the developing Asian currencies, it will be impossible to do so as central banks around the world grapple with the inflation versus growth trade-off.
Given a potentially rising interest rate scenario across the developed world, the dollar is unlikely to make any major (relative) gains in the medium term as its yield will continue to look unattractive. American interest rates are likely to remain lower than most (except Japan's).
The unfortunate consequence of that twist is that it would mean that - in addition to the already high input costs - UAE firms and investors would face a rising cost of funds without any corresponding gains in the purchasing power of the dirham and its anchor currency, the dollar.
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