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Thu 7 Feb 2008 03:15 AM

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'Cut money supply,' IMF warns Gulf states

Strict fiscal policy is the only effective way to curb soaring inflation, official says.

Gulf Arab states must apply strict fiscal policies by tightening money supply to curb inflation, which has soared because of supply constraints in housing and commodities, an International Monetary Fund official said on Wednesday.

"Fiscal policy is the only effective instrument" to control inflation in GCC states, Gene Leon, deputy chief of the IMF's GCC division, told a conference on inflation in the oil-rich region.

GCC partners Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE should "reduce the amount of money available to spend," Leon said.

The IMF expects overall GCC inflation to rise to 6% in 2008, but consumer prices in some member states, like the UAE and Qatar, have run at higher levels, registering 9.3% and 11.8% respectively in 2006.

Most final inflation figures for 2007 have not been released, but the IMF had expected inflation to drop to 8% in the UAE and increase slightly to 12% in Qatar.

Leon said that GCC countries, currently enjoying windfall oil revenues on the back of record-high crude prices, are experiencing "high aggregate demand resulting from domestic investments and increased government expenditure," in addition to high credits available to the private sector.

This high demand faces supply constraints caused by "tightness in the housing market and a rapidly increasing population due to an inflow of expatriates," he added.

The rising cost of housing has been the driving force behind inflation in the UAE and Qatar, while the increase in prices of non-food goods and services were the major factors fuelling inflation in Saudi Arabia and Kuwait, he said.

Saudi Arabia saw inflation officially exceed 4% in 2007 - in contrast to several years of almost stagnant low inflation.

Five of the six members of the oil-rich Gulf bloc also have their currencies pegged to the US dollar, which limits classic monetary policy tools like increasing interest rates, Leon said.

The peg to the weakening US currency has also forced monetary authorities in most GCC countries to track the US Federal Reserve in cutting interest rates despite their robust economies, unlike the slowing US economy.

UN Development Programme regional representative Khaled Alloush slammed the decision of GCC countries - except Kuwait - to maintain the currency peg to the dollar, saying it forced unwise monetary policies.

"Central banks just follow the Fed in cutting interest rates when they need to increase interest rates to reduce demand," he told the conference.

But Leon said that the choice of an exchange rate regime "should be motivated by more than just the need to reduce inflation."

He pointed out the need to bear in mind the exchange rate regimes used by trade partners, implying that they are mostly dollar-pegged.

The IMF official argued that a revaluation of local currencies - an option being discussed following the dollar's depreciation - would have a short-lived effect on prices adding inflation was fuelled by supply-side factors.

Several GCC countries have introduced dramatic wage hikes - up to 70% in UAE federal government departments - in a bid to combat the impact of inflation, but there are fears this could push up demand and add to inflationary pressures.

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