Persian Gulf states face ‘inflationary spiral,’ Moody’s says

January 30, 2008

DUBAI (Bloomberg) -- Persian Gulf states, including Saudi Arabia and the United Arab Emirates, may create an “inflationary spiral” as governments boost spending in response to higher prices, Moody’s Investors Service said.

Increased government spending on salaries and subsidies, aimed at alleviating the effects of inflation, may stimulate demand, leading to further price rises, said senior analyst Tristan Cooper, in a research note released Tuesday.
Inflation accelerated to records in all six Persian Gulf Cooperation Council states during the past year, fueled by higher government spending and a falling dollar, to which most of their currencies are linked. Federal employees in the UAE were given a 70 percent salary increase at the beginning of 2008.
“The danger is that governments across the PGCC may find it increasingly difficult to limit expenditure growth in the face of rising inflation, thereby locking themselves into higher and higher oil prices in order to balance their budgets,” Cooper said in the note.
Kuwait based its 2008 fiscal year budget on an oil price of $58 per barrel, compared with $36 in the previous fiscal year, while Saudi Arabia’s 2008 budget assumes a price of $45 per barrel versus $38 per barrel in 2007. PGCC Inflation
Inflation averaged 6.3 percent in the six PGCC countries in 2007, versus 0.3 percent in 2001, Merrill Lynch said in a report Monday. Inflation in the UAE rose to a record 9.8 percent in 2007 from 9.3 percent in 2006, according to the median estimate of seven economists surveyed by Bloomberg in December. Consumer prices increased an annual 6.5 percent in Saudi Arabia, the largest Arab economy, in December.
Saudi Arabia Monday approved a 17-point plan to address the impact of inflation, including a 5 percent wage increase, continued subsidies and a lowering of tariffs on imported goods.
Kuwait last week said it would increase spending in its new budget by 58 percent. Dubai, the second-largest of seven UAE sheikhdoms, said it will raise spending by 31 percent this year.
“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 revenue,” Cooper said.
While the potential impact of this higher spending on Persian Gulf states’ credit ratings in the short to medium-term is limited, “there could be longer term implications,” he said.
Saudi Arabia’s long-term foreign debt is rated Aa3 by Moody’s, the fourth highest grade, as are that of Oman and Bahrain. Kuwait, Qatar and Abu Dhabi, the largest of the seven sheikhdoms that make up the UAE, are rated Aa2, a step higher. The UAE does not currently have a sovereign rating.
The credit ratings of the Persian Gulf’s wealthiest nations are constrained by political risks, the development of domestic institutions and economic dependence on oil and gas, Moody’s said in a Nov. 7 report.