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Tue 29 Jan 2008 01:33 AM

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Gulf spending threatens future ratings

Increased gov't spending could trigger inflationary spiral with grave impact - Moody's.

GCC governments risk triggering an inflationary spiral as they ramp up expenditure, leading to an impact on future ratings, Moody’s Investor Services warned on Tuesday.

Despite limited consequences for governments’ creditworthiness in the short to medium term, there could be longer term adverse implications, the ratings agency said in a new Special Comment.

According to Moody’s, the GCC’s unweighted average nominal growth in government spending rose from 4% in 2002 to 22% in 2006, and expenditure growth is likely to have been strong across the region as a whole in 2007.

A sense of social obligation contributed to pressure on governments to raise expenditure, the agency said.
“As hydrocarbon export revenue accrues directly to governments through their ownership of oil and gas producers, they feel socially obliged to redistribute oil wealth through higher public spending, typically resulting in a pro-cyclical fiscal policy,” analyst Tristan Cooper said.

“The economically justified desire to raise public investment levels in order to stimulate private investment, foster economic diversification, and raise potential growth rates has been another key driver” Cooper added.

However, the region has seen sharp inflation rises over the past two years, eroding purchasing power, leading to demands for salary increases and subsidies and significantly raising the cost of purchasing goods and services.

Attempts to offset the effects of inflation by raising salaries and subsidies may provide short-term relief to citizens, but risk exacerbating price growth by stimulating demand, which would in turn generate further calls for spending hikes.

“Such an inflationary spiral would be difficult to control in the absence of other policy
options: Gulf states’ fixed exchange rate pegs and open capital accounts rule out a significant tightening of monetary policy. In fact, monetary policy has had to be loosened in response to recent interest rate cuts in the US,” Cooper cautioned.

The robust creditworthiness of GCC governments is unlikely to be undermined by strong spending growth, Moody’s acknowledges, however “the danger is that governments will find themselves dependent on ever higher oil prices to balance their budgets, making it more difficult for them to adjust in the event of a downturn in revenues. Large increases in current expenditure are of particular concern as they are more difficult to reverse than hikes in capital spending in the event of a potential downturn in revenues.”

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