Inflation

Containing soaring inflation is the biggest challenge ahead if the UAE wants to meet its economic targets for 2010, a new report says.

Although the nominal gross domestic product (GDP) grew by 23.5 per cent in 2006 to reach Dh599 billion while real GDP grew by 8.9 per cent, Dubai-based HC Securities Brokerage said the UAE's biggest test lies in its ability to combat soaring inflation rates.

Prices grew by 7.7 per cent in 2006, up from 6.2 per cent in the previous year.

The surge was driven by many factors such as escalating rent rates and liquidity from petrodollar funds. Rents accounted for 36.14 per cent of the consumer price index, the brokerage firm said in a report titled Yesterday, Today and Tomorrow.

"Inflation is the UAE's biggest concern presently, though there seems to be little that can be done to buck the trend amidst an economy operating under a fixed exchange-rate regime." The devaluation of the dollar against other currencies and the heating up of the economy also rippled through the UAE in the form of higher prices, the report said.

Excessive demand for housing from a growing pool of expatriates moving to the UAE put pressure on rents. These have more than doubled since 2004 and, according to the Dubai Municipality census, rent rates soared by an average of 37 per cent in 2005.

Rising wages amid a robust economy and a shortfall in housing units will add to inflation, said the report.

In January 2007, wages rose by 25 per cent for locals and 15 per cent for expatriates in the government sectors.

"This is expected to stimulate instantaneous demand in the economy and thus push prices upwards.

"To top it all off, strong economic growth rates are expected to be seen in 2007 and the years ahead, expanding the job market and bolstering demand, further driv ing the inflation rate upwards," says the report.

It is believed rent prices will fall, taking inflation down, on the back of the increase in supply of housing units.

However, HC Securities estimates demand for housing units will still fall short of supply in 2007.

The capped increase in rental prices by seven per cent in Dubai and Abu Dhabi might cool off inflation. However, the report said that the previous 15 per cent cap in Dubai since 2005 had an "almost negligible" effect.

To combat the global inflationary trend, HC Securities said an upward revision of interest rates is more probable than a downward one.The UAE is thus expected to tighten its monetary policy.

Although monetary policy has been "ineffectual" under a fixed exchange-rate regime, instruments such as certificates of deposit used by the UAE Central BankUAE Central BankLoading... have absorbed excess liquidity from the market by increasing interest rates.

This has helped eradicate the spread between the interest rates of the dirham and the United States dollar. The Central Bank is constrained by its inability to manipulate interest rates to control inflation - limited by the dollar interest rate changes.

"Hence, there might be a growing need for utilising other instruments and/or policies that are not affected by the US monetary policy to tame the inflation rate.

"It is plausible to believe that the Central Bank has realised that this could be accomplished by implementing a rent cap, liberalising the imports of some basic items, and possibly manipulating the personal loan limit, the capital adequacy ratio and the minimum reserve requirement," says the report.

Petrodollar flows are not expected to increase this year to the extent they rose in 2005