Paradox of plenty...

Ever imagined a situation where having more money is bad?!! ... suddenly it reminds me of Uncle Scrooge (the cartoon character) who used to say 'More money is always good for health'

GCC countries are facing a peculiar problem called 'Paradox of plenty' ... yeah, having more and more oil revenues is actually proving to be a disaster for these economies nowadays. One doesnt have to be an economist to understand that more money you have the more you can spend it as well. Hmm ... however spending more money means that you artificially inflate the price of commodities which are avaliable cheaper and then comes into picture the inflation dragon. Sometimes inflation does play a 'Casper' however it is a ghost afterall.

So lets first understand where did inflation come from .... the answer is not as easy as one would think - its actually a combination of multiple things explained as: firstly, a USD peg when Mundell, MC Kinnon and Kenen's theory proves that Gulf economies and US are no more an "Optimum Common Currency Area"... a falling US dollar meant increasing import prices and since any of the Gulf countries hardly produce goods of basic neccessity the price was surely gonna go up! ... Secondly, as the prices went up the demand for short term funding in name of personal loans started to rise (leave aside an laready looming public debt amount drawn to finance asset price bubbles - specially in the UAE) adding more liquidity in the market. However, these two reasons didnt pose a major risk previously. This was because while the local government's were investing their petro dollar's outside the region, foreigner's were actually pooring in money into the Gulf economies anticipating removal of USD peg's by some of these economies. Due to this available liquidity the interest rates were low and financing inflation or an asset bubble was an easy option.

However, as the anticipation of removing peg's abated we saw the foreign money returning to its destination and a huge shoot up in the short term interest rates (as much as 40% in a month's time). This is a good thing to have, high interest should correct inflation over the long run, however, in the short run it creates tremendous squeeze for liquidity so much so that it affects corporate productivity for every business (the ROC is no longer greater than the COC). Also, if one was to look at the real growth equation: its a function of marginal change in employement and marginal change in productivity. And in the short run both employement and productivity suffer affecting the growth of the economy. GCC equity markets have been hammered (may be 'hammered' is a soft word to use) because the visibility on growth has dwindled. Banks are indeed facing a miny liquidity crisis ( no matter how much one denies), Real Estate: main driver of these economies is showing signs of weakness, government intervention is at its peak and all possible efforts to restore balance in the economy have been made.

Usually, the 'Paradox of Pleanty' is a self-correcting phenomenon and hopefully this correction should happen over the next year. However, governments in the Gulf countries have to re-think their strategies on USD peg, diversifying the growth base away from construction and real-estate, increasing credit standards to avoid piggybacks and most importantly have a regime to control inflation and increase the affordability of living in these countries for expats.