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Inflation in Saudi Arabia surged to a 27-year high of 8.7 percent in February as the world's largest oil exporter and its Gulf Arab neighbours lowered interest rates to defend pegs to a tumbling US dollar.
Saudi Arabia matched the latest 75 basis point cut by the US Federal Reserve last week along with the United Arab Emirates and Bahrain. Qatar, where inflation is running at 13.74 percent, followed on Sunday.
Qatar also tightened lending curbs on banks for a third time since December, in the latest sign of the growing dilemma for Gulf Arab governments, torn between averting currency appreciation and containing soaring prices.
Unable to use monetary policy, Saudi Arabia has also resorted to lending curbs and measures such as subsidies and wage hikes to cushion the impact of surging inflation, leading markets to bet that it will allow the riyal to rise against the dollar.
At 1307 GMT investors in forward contracts were expecting the riyal to gain 2.08 percent in a year to 3.672 per dollar. "If you have global price rises and the currency is weaker by the day then there is a strong case for currency reform," said Marios Maratheftis, regional head of research at Standard Chartered Bank in Dubai.
The dollar peg is fuelling inflation by making some imports more expensive as the US currency sank to a record low against the euro last week. It also forces the Saudi central bank to track US monetary policy at a time when the Fed is cutting rates to stave off recession.
The Fed has slashed its benchmark by 3 percentage points since September and Gulf central banks have tracked those moves at a time when they should be raising rates to rein in prices.
With oil prices near record highs around $100 a barrel, Gulf Arab economies are booming, driving demand for everything from housing to power and water. Rents led the rise in Saudi inflation in February, surging 18 percent, followed by food costs, which jumped 13 percent, according to data from the central department of statistics. The cost of living index rose 6.99 percent in the 12 months to January 31, the fastest pace since 1981, according to SABB bank, HSBC's Saudi affiliate.
The data showed just how much pressure Saudi Arabia and its neighbours were under to allow currency appreciation or even sever pegs to the dollar to track a currency basket as Kuwait has been doing since May, said Monica Malik, economist at Cairo-based EFG-Hermes investment bank. "A revaluation will help to dampen inflation somewhat, but more importantly a move to a basket will increase monetary policy options...," said Malik.
"On an economic basis, the US dollar does not make sense anymore," she said. Saudi Arabia has repeatedly ruled out any change in the riyal's exchange rate which has been fixed at 3.75 per dollar since 1986, although Qatar and the UAE have urged neighbours preparing for monetary union to consider currency reform. Inflation is a more serious political problem in Saudi Arabia, the Gulf's most populous country, than in Qatar and the UAE, which have smaller, wealthier populations dominated by expatriates.
The Saudi king's advisers summoned the finance minister and the central bank governor to discuss inflation last month and the government increased public sector wages, welfare payments and subsidies in January to help keep a lid on public discontent. The UAE, Bahrain and Qatar have also turned to price controls and measures such as tighter lending rules as they cut interest rates in tandem with the Fed.

Copyright Reuters, 2008

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