5% inflation target for ’08 'not feasible'

UAE's move to target inflation at 5 per cent this year to rein in sky-rocketing price increases would be ineffective unless the country adopts a flexible monetary policy, economic analysts said.

"There is a lack of flexibility in UAE's dollar-pegged monetary policy. Only a UAE currency that reflects the underlying economic fundamentals will serve as an effective tool to fight soaring inflation. Tracking the monetary policy of the US Fed, which has cut dollar rates will only serve to ignite UAE's inflation which is currently hovering around a record 12 per cent," a Dubai-based analyst said.

In its struggle to check recessionary trends, the Fed has cut rates by more than three percentage points in six months to 2.25 per cent while rendering the greenback weaker against most major global currencies. Consequent to this, the value of dirham, pegged to the dollar also dropped, sparking steep price hikes of imported items.

"Seeing as how the dirham’s value is diminishing due to the dollar peg, we ponder whether this (inflation targeting) seems like a realistic enough goal to set," say analysts Reem Mansour and Yasmin El Batrawy.

"We find it unfeasible for the Ministry of Economy to set an inflation target of 5.0 per cent for 2008, especially with the strong persistence to maintain the dollar peg, resulting in a lack of flexibility in monetary policy. We believe that for the UAE to begin targeting inflation in an effective manner, it is only reasonable that the Central Bank consider revising its monetary policy," said the analysts with HC Securities Brokerage.

Last month, the UAE in a move to arrest spiralling inflation set an inflation target of five per cent for 2008. Sultan bin Saeed Al Mansouri, Minister of Economy, said his objective was to bring down inflation by more than 50 per cent within this year. UAE's inflation, which was 9.7 per cent in 2006, and an estimated 11 per cent in 2007, is forecast to be more than 12 per cent this year on the back of soaring rents, increasing food prices, and a weakening currency pegged to a plummeting dollar.

Inflation targeting, as a promising monetary policy framework, will facilitate control of inflation and made monetary policy more transparent and accountable. An inflation targeting policy will favourably improve the competitiveness of the economy, financial market and business environment and has substantial impacts on the banking sector.

With the US economic data painting a gloomier outlook, the dollar is expected to drop further. "With expectation of a weakening dollar it does not look like the inflationary situation will be improving any time soon. Instead, it is more likely that imported inflation will be even more exacerbated, as the falling value of the dollar depletes the purchasing power of the dirham, causing imports to become even more expensive," they said.

Nations exporting to the UAE, such as India, which comprises 12.3 per cent of the UAE’s imports, Brazil, which makes up 1.3 per cent of the country’s total imports, and Sri Lanka, and Russia, have now started to quote prices of commodities in Euros rather than dollar, in order to ensure price stability.

Compounding the inflationary trend government expenditure on development projects and the increase in subsidies. Source