Inflation in UAE

Introduction.

            Inflation has been a challenge to most world economies due to the problems it presents to them.  Inflation decreases the standards of living of the people and makes it harder for them to afford the basic goods and services.  Before discussing more about inflation, it is important that we define it, so that we may understand it better.  According to Oxford Business Group (2007), inflation is the general rise in prices of services and goods over time, in an economy.  It can also be referred to as the decrease in purchasing power or real value of money.  It is important to note that the two definitions are similar, since the increase in prices of goods, leads to fewer services and goods that can be bought by each unit of currency.  Inflation is primarily measured by the inflation rate, and this indicates the percentage change in value of currency over time.

            Inflation has adverse effects, most of which are attributed to uncertainty over the future.  These make investors less confident of investing in countries that experience high inflationary trends, since they are not sure that they will receive favorable returns.  This has a negative effect on the economy of such countries.  According to Business Monitor International (2003), inflation also presents challenges to consumers, since it limits their purchasing power.  Excessive inflation also affects the social sector and causes poor income distribution, decreased savings, lower wages among other negative social effects.

Inflation trends in UAE

            Over the recent past, the increase in inflation levels in the UAE has threatened the survival of many businesses, including those in the real estate sector.  In 2007, the reported rate of inflation in the UAE was 11.1%, which was the highest rate in the last two decades.  Since 1997, the inflation levels decreased over the next two years to 3.6% and 2% respectively.  However, since 2000, inflation has gradually risen to date, without showing signs of decreasing.  This is a trend that has made experts sound a warning to the government.  For instance, between 2000 and 2006, inflation rose from 2.1% to 6.5%, which is a significant growth over just six years.  This is the major reason why experts warned the government over the inflation rates and attempted to find solutions to the problem.

Causes of inflation in the UAE.

Pegging to the dollar

            The inflation in UAE is increasing at a fast rate due to the fall in the US dollar.  The UAE pegs its currency on the dollar, which means that the UAE follows the United states monetary policy.  This limits the initiatives that can be used to control inflation.  Currently, due to the economic crisis that the US is experiencing, it has been forced to slash its interest rates, as a means of mitigating the damage caused by the crisis.  Since UAE pegs its monetary policy according to that of the US, this has also made it slash the interest rates to match those of the US.  The effect of this has been the increase in demand for credit, which leads to high rates of inflation.  This has an adverse effect on the economy of UAE, due to the negative effects of inflation to the economy.

US mortgage crisis.

            The US economy is current facing a form of recession, which was partly created by the mortgage crisis facing the economy.  The US mortgage crisis has a direct effect on the property prices in UAE, especially in Dubai.  Some of the major investment banks that collapsed have subsidiaries in UAE, and others have major investments in the same country.  Many banks in UAE are wary of lending money due to fear of collapse due to this crisis.  The overall effect of the crisis is to reduce the ease of getting loans from banks, which leads to payment of higher levels of mortgage, thereby pushing the property prices upward.  This increases the rate of inflation.

Imports by foreigners.

            Another cause of inflation in the UAE is the increase of imports by foreigners in this country.  The expanding economic opportunities have led to the increase of foreigners who either invest or to look for employment opportunities.  The expatriates usually import a lot of goods for consumption and this has the effect of pushing prices upwards.  An illustration can be given through analysis of the automobile industry.  An increase in importation of vehicles has led to increase in prices for such cars, since there is no local manufacturer.

Government spending.

            The UAE government has practiced massive spending that is being linked to the high inflation levels.   For instance, in 2007, the government implemented a 70% pay hike to government employees who totaled 60,000.  This was seen as a huge amount of money, and it served to increase the purchasing power of these people.  When the purchasing power of 60,000 people is increased by 70% simultaneously, this is bound to affect the prices of goods.  According to Oxford Business Group (2007), these people increase the demand of goods and services, thereby pushing their prices upwards.   The effect of this spending alone is estimated to cost Dh3.5 billion, and may make suppliers artificially increase prices of products so as to take advantage of the situation.  The economic surplus that the country has experienced is the major factor that is increasing government spending, thereby increasing inflation levels.

Increased prices of goods and services.

            According to Finafrica (2003), the rising fuel prices have negatively affected many countries, since they increase the cost of producing goods and services.  Manufacturing industries have born the brunt of the increase since they rely on fuel the most.  These high costs are eventually passed on to consumers by the manufacturers.  This increases the rates of inflation.  The rising cost of rent due to the rise in property prices can also be blamed for the rise in inflation

Challenges brought by inflation in UAE.

            The rising rates of inflation are hindering the growth of the non-oil sector in UAE.  In its strategic growth plans, the UAE government decided to diversify its investments in order to reduce reliance on the oil sector.  This was considered to be a strategy that would cushion the UAE economy in case adverse effects hit the oil sector.  However, in order to diversify the investment, there is a strong need for foreign investors who invest in non-oil sectors.  The rising inflation trends are serving to discourage foreign investment, due to the uncertainty in returns, which makes it difficult for the UAE government to achieve its diversification objectives.

            Inflation is also affecting the purchasing power of consumers.  For instance, in Dubai a year ago, a carton of bananas was worth 25 dirhams but they currently cost 48 dirhams.  According to Cooper (2008), when there is a significant change in the prices of basic goods, this is an indicator of the problems consumers are going through.  Another sector that is currently suffering due to inflation is the property sector.  Apart from the costs of material that have doubled over the last few years, property developers in Dubai are finding it difficult to access credit due to the credit crunch in US that is raising the levels of interest.  This makes it not only difficult to afford housing, but also difficult to invest in real estate in this country.

Conclusion and recommendations.

            It has been observed that inflation poses a challenge to the economy of UAE due to the adverse effects that it has on it.  It is therefore imperative that the government takes drastic steps to ensure that the inflation level is at a manageable level.  The first step that the UAE government should take is to reverse the policy of pegging its currency to the dollar, so as to prevent the inflationary trends of the US dollar from affecting its economy.  When it stops pegging its currency to the US dollar, this will ensure that the adverse effects that are currently facing the US economy have lesser impact on the UAE economy.  UAE should further emulate the example that was set by Kuwait, which severed its links with the US dollar.  Since then, this country has enjoyed massive benefits that include the rise of its currency by over 9%.  These are similar benefits that can be enjoyed by UAE if it were to emulate this move.

            The UAE government should also control its levels of spending since they have been seen to contribute to the rise in inflation levels.  The government should for instance not award huge price increases to government employees at once, and it should instead award the increases in phases.   The monetary authority should play a crucial role in advising the government on the impacts of its policies on inflationary trends in the economy.  This will ensure that not only are goods affordable to consumers, but also that the environment is conducive for investors.

References.

Business Monitor International. (2003). Middle East Monitor. UAE: Business Monitor    International.

Cooper, P. J. (2008). Opportunity Dubai: How I Made a Fortune in the Middle East. UK:           Harriman House.

Finafrica. (2003). Savings and Development. Italy: Finafrica.

Oxford Business Group. (2007). The Report Abu Dhabi 2007. London: Oxford Business           Group.

Oxford Business Group. (2007). The Report Dubai 2007. London: Oxford Business Group.

 

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