Global Investment House – Kuwait – UAE Economic and Strategic Outlook – Inflation – Inflation continued to be a concern for the UAE economic progress and was at all time high of 9.3% in 2006 as recorded by Consumer Price Index. The reported consumer price index (CPI, 1999-2000=100) increased from 121.7 in 2005 to 133.0 in 2006.
Consumer Price Index
End of Period (2000=100) Weight 2003 2004 2005 2006 y-o-y increase
Food, Beverages and Tobacco 14.4% 104.7 112.0 117.0 123.5 5.6%
Clothing and Footwear 6.7% 106.6 112.0 114.8 119.2 3.8%
House Rent and Related House Items 36.1% 112.7 119.0 130.1 150.1 15.4%
Transport & Communication 14.9% 106.6 111.5 116.6 127.7 9.5%
Furniture and Related Items 7.4% 104.4 106.9 110.5 113.2 2.4%
Medical Care & Health Services 1.9% 115.3 117.0 123.4 127.5 3.3%
Recreation, Education & Cultural Services 10.3% 114.7 117.1 121.7 124.6 2.4%
Other Goods & Services 8.2% 103.9 111.1 117.8 125.0 6.1%
General Index 100.0% 109.1 114.6 121.7 133.0 9.3%
Inflation 3.1% 5.0% 6.2% 9.3%
Source: CBUAE
The increase was seen in all major spending categories. However, the maximum increase of 15.4% was seen in “House Rent and Related House Items” category, followed by “Transportation and Communication” which recorded an increase of 9.52%. Collectively the two categories constituted 51.1% of total spending weights and were the main driver for high inflation in the cost of living.
The increase in housing was predominantly due to demand-supply mismatch. Commercial and residential rents almost doubled in Dubai and Abu Dhabi between 2004 and 2006. Although some new housing stocks have become available in 2007, the demand for accommodation still seems to be outstripping supply, putting upward pressure on rent levels. The price index for the transportation and communication category rose from 116.6 in 2005 to 127.7 in 2006 owing to a rise in the prices of diesel and increased taxi cab charges, particularly in Dubai and Sharjah.
Inflation on essential food items such as “Food, Beverages and Tobacco”, Clothing and Footwear” were relatively much lower at 5.6% and 3.8% respectively when compared with Housing and Transportation categories.
The UAE is facing the problem of inflation with extra-loose monetary policy, strong domestic demand, and supply constraints. Also, the oil boom has led to a sharp increase in economic activity which has attracted an increased inflow of expatriates to the country. The country needs to import much of essential commodities and with the US$ depreciating against major currencies; this has resulted into imported inflation as well. While Dubai has invested significantly to alleviate these issues, supply constraints, especially in real estate, is more pronounced in Abu Dhabi, which is following in the footsteps of Dubai in launching mega projects.
The government is making sincere efforts to control inflation. In order to have a check on substantial rent hikes in the housing market the government has introduced rent caps. This was first introduced in Dubai at 15% then lowered to 5.0% on December 30th, 2007. In Abu Dhabi rent cap is at 7.0% while in Ras Al Khaima and Fujairah at 15.0%. The move seems to have been partially successful, reducing the annual rate of rent increases. However, the rate of increase is still significantly higher than the cap, suggesting widespread non-compliance. Furthermore, there is no protection for new comers or those changing accommodation as the rent cap, even when enforced, is only applicable to renewals.
Other efforts of the government include building affordable housing to the worker population at large. In February 2007, Dubai Industrial City (DIC) announced the completion of its Base Metal Zone Labor City – the first of seven Labor Cities that are planned for construction at a cost of AED1.6bn. The project is part of a master plan to provide affordable, self-contained accommodation with full commercial and leisure facilities within easy access of production centers. DIC plans to complete the construction of all seven cities by early 2008. When completed the Labor Cities will cover 14 million square feet and will provide almost 90,000 beds for supervisors and groups of workers.
In a yet another move, on January 6th, 2008, the government announced that it will issue bonds on attempts to fight inflation. This would help tighten the money supply and help check inflation. The government is also looking at other means such as, providing subsidies and wage increases, to check on inflation.
Debate is currently on whether the country should de-peg its currency from the US$. The US and the GCC economies are at very different stages in their respective economic cycles. On one hand, the US is facing a sharp economic slowdown and declining housing demand; the GCC is awash with liquidity and experiencing a period of strong growth. Due to the peg, the central bank is unable to stem monetary growth by adjusting interest rates independently of the US Federal Reserve. Also the currency weakness has pushed up the import costs leading to substantial increase in construction costs as well as consumer price inflation.
The Central Bank persists on continuing with the peg stating that it has served the country well for so many years. However, going forward, much would depend on the direction of the US$ movement. A prolonged and steady decline would make the case for revaluation difficult to ignore.
