A slump in the value of the dollar and a global political showdown over currencies may push prices higher in the Gulf Arab region, which lacks a flexible monetary tool to control inflation.
Gulf currencies are pegged against the greenback, leaving little room for governments to shape independent monetary policies, except in Kuwait, which dropped its dollar peg in 2007 in favour of a basket of currencies.
The dollar has been under pressure recently and prices touched fresh lows for 2010 this month on the view that further quantitative easing by the US Federal Reserve would not help the US currency.
Rising inflation has already been a major concern for major Gulf economies such as Saudi Arabia and Kuwait. That is especially the case for food, which is mostly imported from outside the arid region and exposes Gulf economies to fluctuations on international markets. "The prospect of further dollar weakness is less favourable with imported food inflation becoming a clearer risk," economists at Emirates NBD wrote in a recent research report.
The trend is towards rising food inflation in most Gulf economies, Emirates NBD said, with prices increasing 11 percent year-on-year in Kuwait and eight percent in Saudi Arabia.
Saudi Arabia, which is largely desert, relies heavily on food imports to feed its rising population and is hence vulnerable to rising commodity prices and falling dollar values.
Investors will be looking for an agreement on how to deal with global imbalances at the G20 meeting in South Korea, a failure of which could hurt financial markets in the short-term by increasing the likelihood of quantitative easing and creating more pressure for currency intervention. Despite the sharp drop in the dollar's value, a heated debate about currency pegs and government intervention is unlikely to emerge this time around, most economists say.
Speculation over the viability of dollar pegs emerges frequently in the Gulf Arab region. Back in 2007, when similar speculation swirled, investors heavily bought local Gulf currencies offshore against the dollar to bet on a revaluation.
"Despite accelerating inflation and the recent weakness in the dollar vis-a-vis global currencies, we do not anticipate the debate over whether Gulf states should revalue their currencies will resurface," John Sfakianakis, chief economist at Banque Saudi Fransi, said in a recent report.