09 May 2008
Kuwait, the only Gulf Cooperation Council (GCC) member state to drop its dollar-peg, has not managed to escape the current inflationary cycle affecting the region. The rising cost of oil, coupled with the declining dollar, is piling inflationary pressure on the economy. Now the governor of Kuwait's central bank is encouraging the government to take action.

One area highlighted as causing particular concern is the housing market. Sheikh Salem Abdul-Aziz Al-Sabah, Governor of the Central Bank of Kuwait (CBK), told reporters that, "In this period, the importance of state efforts to oversee the housing market and bring back a balance to the real estate market is clear." Analysts have interpreted the comment as the CBK favouring the introduction of a government-sponsored rent cap.

A rent cap would be more popular with the CBK than the government's previously preferred strategy of further state sector pay rises. The Kuwaiti government employs over 90% of Kuwaitis and demands to raise government wages are featuring prominently in the current election campaign, with voting due to be held on May 17.

Wages were last increased as recently as February, when a 120 KD ($450) monthly "bonus" was paid out to all Kuwaitis employed in the public or private sector. Non-Kuwaitis employed in the state sector were awarded an increase of 50 KD ($187). Sheikh Salem appeared against further increases in state spending, advising the government not to heed to "political pressures". "We can see the first negative signs of such an increase," he said, in an apparent reference to the February increase, and other large-scale public spending programmes.

Recently released figures for January show inflation in Kuwait rose to 9.5%. Housing prices increased by 16.1%, while food jumped 7.7%. While high, Sheikh Salem noted that the level remained "relatively moderate compared to inflation in other countries of the Gulf Cooperation Council". Qatar (13.7%), Saudi Arabia (9.6%) and the United Arab Emirates (around 12%) all currently have higher levels of inflation than Kuwait.

Even having dropped its dollar peg and shifted to a basket of currencies (thus in theory giving it greater control over its monetary policy) Kuwait is still limited in its ability to reduce the inflationary pressures currently assailing its economy. Sheikh Salem revealed the CBK was using "mainly non-direct monetary policy tools to readjust the level of local liquidity", i.e. selling bonds to reduce the amount of paper in the economy.

Since dropping the dollar peg last May, the Kuwaiti dinar has appreciated by around 9% against the greenback. One advantage of regaining an independent monetary policy for the Kuwaiti economy has been the ability of the CBK to avoid trailing the heavy-cutting policy of Ben Bernanke's Fed, which has slashed rates by 3.25% since last September.

The CBK cut its discount rate by 50 basis points in January to 5.75%, in partial imitation of the Fed's shock-therapy cut of 75 basis points. Since then the discount rate has remained stable, while the repo rate is at 3.5%. The latter is now 1.5% higher than in the UAE, which was last week forced to cut its repo rate even further down to 2%.

With oil now trading at close to $120 a barrel, and OPEC president Chekib Khelil predicting $200 as a real possibility, there is a limit as to how much inflationary wind the CBK can knock out of Kuwait's economy. The government may well reason that, with so much surplus revenue, and with the addition of external pressures on purchasing power such as the rising global cost of basic food, it may well bite the bullet and agree to a further wage increase for nationals.

By doing so, the government risks triggering an inflationary cycle. Yet Kuwait's economy is not overheating quite so rapidly as other Gulf States. Year-on-year broad money figures for March show growth of just under 20% - high, yet significantly lower than the UAE, whose February figure was 33.8%. It is a tough call for a government that will need to maintain public support if it wishes to push through the economic reforms which led to the dissolution of the previous parliament.

© Oxford Business Group 2008