Soaring inflation undermines sustainability of Persian Gulf region

States scramble to protect themselves from skyrocketing energy costs, but measures such as government subsidies are proving ineffective.

Just as Persian Gulf cities such as Dubai and Abu Dhabi were becoming synonymous with excess and success, the Gulf boom is in danger of going bust. Instead of conjuring images of towering skyscrapers and indoor ski slopes, they are struggling with soaring inflation rates. Indeed, the Gulf region may want to position itself at the center of global capitalism, but it will first have to contend with the impact that skyrocketing energy costs and a cooling global economy are having on the local economy and the impoverished migrant labor force that bears the brunt of rising oil and food costs.

High inflation is causing concern among policymakers in the Gulf Cooperation Council (GCC), a regional organization that includes Saudi Arabia, Kuwait, Bahrain, Qatar, Oman, and the United Arab Emirates (UAE).

In June, inflation in Egypt, the most populous Arab country, hit a 19-year high of 20.2 percent. Saudi Arabia also saw a 30-year inflation high of 9 percent in May. Meanwhile, inflation in Bahrain rose from 4.07 to 6.2 percent between December 2007 and April.

To make matters worse, five of the six GCC members, with the exception of Kuwait, peg their currencies to the US dollar. As its values drops, their inflationary woes grow, and the sustainability of economic growth in the Gulf is brought into question.

Previously, the prosperity of Gulf states such as Bahrain and Qatar has come from the soaring price of oil, which has reached record highs over the past 12 months. But now, rising oil prices are spurring further inflation.

According to Rasheed Mohamed Al Maraj, the chairman of the Central Bank of Bahrain, 50 percent of the world's proven oil reserves can be found in the GCC countries. Over the last 12 months, the price of oil has risen dramatically, with a barrel costing $147 at the end of last week. As a result, Gulf-region economies have been growing at a rate of 5 to 7 percent a year for the last several years.

But as Mr. Al Maraj explains, this price hike is exacerbating the region's inflation woes. "[The price of oil] creates pressure on the economy and is bound to create inflation," he says. "It is like running a machine for a long time – eventually it overheats."

The region's poor are the worst affected. Gulf states are trying to spend their way out of the problem by increasing public assistance to the poor and raising subsidies on food, fuel, and housing.

In Bahrain, for example, the government has increased subsidies on food, fuel, and housing for the poor. In the past year, the island kingdom has spent more than 500 million Bahraini dinars (approximately $1.32 billion) on subsidies.

To combat possible food shortages, some states are looking abroad to lease large tracts of farmland that are more fertile and less expensive to maintain than land in the Gulf region.

Earlier this month, Abu Dhabi announced that it had leased 30,000 hectares of land in Sudan to grow food to be imported to the UAE. The Egyptian Trade Ministry also announced that negotiations with Abu Dhabi to develop farmland were under way. But the effects of these agricultural deals have yet to be felt.

Economists say that rising inflation hits the poor the hardest since they spend a higher share of their income on essential goods such as food. As prices for unsubsidized foodstuffs rise, more people scramble to save pennies by purchasing subsidized products, which puts pressure on an overextended subsidy system.

In Egypt, the demand for subsidized bread between January and April led to what local media called a "bread crisis." The shortage sparked violence in which a dozen people died.

But the worst-affected are noncitizen laborers from South and Southeast Asia, who often rely on public services to survive. "In the Gulf, part of what creates this pressure is the huge influx of manpower to service our countries," says Al Maraj. He adds that the demand for public assistance is growing faster than the government can dole it out. "As soon as there is a new supply of services and housing, the demand just grows again," he says.

For some migrant workers, inflationary pressure is less acute because the companies that hire them pay for key items like food and transportation. But inflation remains a significant problem for those foreigners whose families back home are demanding more remittances to meet rising prices.

"Our salaries were low to begin with," says A. Sridhar, an Indian national from Kerala who has lived in Abu Dhabi for more than a decade. Mr. Sridhar, who works as a waiter, earns 500 Arab Emirate dirhams (approximately $136) each month. "I'm sending all my money back home so that my family can afford food.... I was usually sending 300 to 400 dirhams home and keeping the rest for transport and medicine."

Now Sridhar, who says he lives in a laborer community outside the city in a trailer that he shares with eight other men, has barely enough to keep for himself, even though his company provides food and lodging free of charge.

In the face of such pressures, Gulf states scramble to address the downside of rising oil profits. "We have to be careful how we think about growth," says Khalid Abdulla-Janahi, the chairman of Bahrain's Ithmaar Bank. "This is about people, and the majority are suffering."

• Matthew Bradley contributed to this report from Abu Dhabi.