Bahrain: Cash Flowing Freely

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While inflation in the kingdom is relatively low, near record levels of money flowing through the Bahraini economy have sparked concerns of a possible inflationary breakout and have prompted moves by the kingdom's central bank to take some of the heat out of the situation.

On May 4, the Central Bank of Bahrain (CBB) released its latest statistical bulletin, covering the first three months of the year. The report showed a steep rise in money supply in the economy, with an increase of 38.9% in the January to March period, compared to 34.8% in the quarter ending in December.

The bank put the total M3 money supply level in the kingdom's economy at $18.73bn, well up on the $13.46bn as of the end of Q1 in 2007. In part, this increase was driven by a strong rise in the levels of time and savings deposits held by banks, which rose by 48.7% to $11.13bn. The increase in money supply was the highest since 2001, and followed on from rises in each month of the second half of last year.

The concern is that, with increasingly high levels of cash available, both private individuals and companies could go on a spending spree, pushing up demand in an economy that is in many sectors struggling to maintain the balance of supply. This in turn would stoke inflationary fires, something the CBB and the government have sought to keep in check.

In March, annual inflation hit 5.24%, low when compared to neighbouring Qatar's 14%, but still up on the 4.82% recorded in February.

Even before its monetary supply report came out, the CBB has been alert in its anti-inflationary platform. Due to the Bahraini dinar's peg to the US dollar, the CBB has been obliged to follow the lead of the US Federal Reserve (Fed) in steadily reducing interest rates. The latest round of cuts came on May 1, when the bank lowered its one-week deposit rate from 2.25% to a flat 2% and its overnight deposit rate to 1.5% from 1.75%, in response to a cut by the Fed.

However, the CBB left its key lending rates untouched, a move aimed at discouraging borrowing at cheap prices and stopping even more money from flowing into the economy. In a previous move to drain off some of the liquidity floating around in the economy, the CBB lifted the bank minimum reserve requirement from 5% to 7% in January.

The day after the CBB released its monetary supply bulletin, the bank's governor, Rasheed Mohammed Al Maraj, said that while Bahrain had been fortunate that inflation had remained at levels below most of its neighbours, continued vigilance was required to keep price rises in check.

"The rising price of oil, while very welcome, has not come without its own challenges. Along with the rest of the world, we, too, are facing inflationary pressures, which need to be carefully managed without compromising the momentum of economic growth," Al Maraj told delegates attending a finance summit in Manama.

However, he also warned that circumstances beyond the control of individual central banks and nations, such as global price rises, food shortages and increasing commodity prices could have an impact on Bahrain, with rising food costs already identified as one of the key drivers in the kingdom's increasing inflation.

Though the government has taken steps to reduce inflationary pressures such as providing foods subsidies for low-income families, supporting efforts to cap price increases in the construction industry and keeping down energy costs, the threat remains that the kingdom's cashed up economy will add to the flames of further inflation.

© Oxford Business Group 2008