By Pratap John
AS QATAR fights inflation which is now in double digits, the focus is on how it actually got to this state.
Will Qatar de-peg riyal from the dollar to arrest imported inflation? Or will it be opting for a gradual transition to a floating exchange rate accompanied by inflation targeting?
Some economists say though de-pegging the riyal from the dollar is necessary, it is not enough to totally rein in inflation. Demand management, they say, is equally important to contain inflation under which a large share of its oil revenue surplus will be kept outside the region.
Qatar’s inflation hit a record 13.73% in September with soaring rents having a cascading effect on the prices of commodities and services. Clearly, the depreciation in the value of the dollar, to which the riyal is pegged, is another major contributing factor.
The severe drop in the rate of the dollar-pegged riyal against other major currencies has increased the cost of imports. As in the case of its Gulf neighbours, Qatar faces imported inflation resulting from pegging the Qatari currency to a weakening dollar. The sliding US currency is driving up import costs and fuelling inflation.
It is no wonder then that almost everyone in Qatar is hit. Spiralling rents have jacked up inflation and they don’t show any signs of letting up either.
While all economists agree Qatar cannot afford to keep inflation at the current levels, they do not seem to be sure of the short term or medium term steps it takes to contain it.
Standard Chartered sees the probability of a GCC currency revaluation within two months; though the bank says there is no consensus on the issue yet.
There is a strong need for currency reform, as GCC countries are importing an expansionary monetary policy from the US, Standard Chartered said recently. They should examine tackling inflation through tighter monetary policies, it said.
“Inflation in the GCC is rising, and it is becoming a concern,” Standard Chartered said.
The three main drivers of inflation in the GCC are excess liquidity, food prices and housing costs, the bank said. Excess liquidity is the dominant theme throughout the GCC.
Food prices are more important when it comes to Kuwait, Oman and Saudi. In their case, a stronger currency will help, given that food is mainly imported.
Inflation in Qatar and the UAE was mainly driven by housing costs, it said.
The problem with the dollar pegs is two-fold, Standard Chartered said.
First, there is a problem of valuation. With the dollar losing more than 35% of its value over the past five years, imported inflation and in particular food price inflation is rising. Food price inflation is a global phenomenon, but a weak currency makes the situation worse.
Second, with the dollar peg there is a problem of flexibility. The dollar pegs, especially now that the Fed is cutting interest rates, are simply not providing the authorities with enough policy options. The GCC is flooded with liquidity, the bank’s economics and research division said.
Because of the dollar pegs, interest rates in the region are kept low, which limits the ability of the authorities to drain liquidity out of the system. The absence of a mature bond market is also another limitation, as the authorities cannot use open market operations and issue bonds to reduce liquidity, it said.
On the other hand, EFG Hermes’ recently said the Gulf countries might opt for a revaluation of up to 5% of their dollar-pegged currencies within six months.
On the prospects of Gulf currencies being pegged to a basket (of currencies), the bank said “it makes sense”.
But given the export concentration in dollar, EFG Hermes said it will predominantly be dollar-denominated but will also have euro, sterling and some Asian currencies as well.
“It gives you the much needed flexibility in your monetary policy besides helping you guard against imported inflation. Currency stability has been a key area of investments and will largely determine the level of future investments,” a bank economist said.
EFG Hermes also said the current high level of inflation being seen in the Gulf region, particularly Qatar and the UAE, was largely due to shortages in the housing market. The decline in the value of the dollar-pegged Gulf currencies also drives inflation. They cause imported inflation.
Standard Chartered said Qatar and the other Gulf countries will benefit from a gradual transition to a floating exchange rate accompanied by inflation targeting.
However, it said, several conditions need to be met for the floating exchange rate and inflation targeting to be successful.
The GCC countries must go step by step to ensure such a policy achieves the desired results. The first point of action can be a significant, 20% revaluation of GCC currencies, with the dollar peg staying and a later introduction of a currency basket dominated by the dollar, the bank said.
Alternatively, it said, the GCC can proceed with moderate revaluation (5%-10%) with a simultaneous introduction of the currency basket. In order to be effective however, it would have to be followed by an immediate introduction of a currency basket.
“The basket can still be dominated by the dollar; however it will give the authorities more flexibility to fine tune and make necessary changes in the future.
If a moderate revaluation is not followed with an introduction of a currency basket, then the GCC will have to follow up with more revaluations in the near future. This will encourage speculation for another one-off move at a later stage, which can lead to the same problems of ample liquidity the region is facing now,” Standard Chartered said. 
Citigroup in a November report said de-pegging should address supply side factors that are feeding inflation in Qatar, but tougher steps are also required to contain domestic demand.
“We believe the demand side factors have not been given sufficient attention in the Gulf region. The commonly held view is that increasing housing and office units to fight inflation is only part of the picture. If demand pressures continue to grow as they have, even increasing supply may not necessarily ease rental increases,” Citigroup said.