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Inflation should be Viewed as Public Enemy Number 1: Here’s why

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By Jannie Rossouw

Inflation is a process of sustained increases in the general price level over a period of time, typically 12 months. Inflation can be calculated for a country, for specific regions in a country and for different income and demographic groups, for instance pensioners. These different calculations are important because the spending patterns of regions and groups differ. That means that their rates of inflation also differ. It is therefore important for each household to have a clear understanding of its own inflation rate.

A number of countries allow for the development of this improved understanding. For example, South African households can use an Internet tool such as the personal inflation calculator of Statistics SA . A personal inflation calculator, based on the spending patterns of household, is also available for the Euro areaCanada and New Zealand.

The phrase describing inflation as ‘enemy number one’ is borrowed from the research done by South African businessman Dr Anton Rupert on the world-wide inflation problem suffered in the 1970s. He described inflation this way due to its distortive impact on the economies of countries and the wealth and financial well-being of households. But the word inflation has a much earlier origin. Its first use was in the US between 1830 and 1860, when the US dollar started losing value. In short, people experience inflation as sustained price increases. Prices continue to increase and the same amount of money buys less goods and services over time.

Why is it so bad?

Inflation is bad because people on fixed incomes such as pensioners get poorer over time. The buying power of their money is eroded. A further problem is that borrowers enjoy an advantage over savers. With high inflation, the capital value of savings is eroded, while the real burden of borrowing declines. It becomes easier to repay debt. Although interest rates increase with higher inflation, the real value of the amount borrowed that has to be repaid, declines as percentage of salaries that are adjusted for inflation.

Governments are the largest borrowers in the world. They are therefore the major beneficiaries of inflation, as the real value of their debt is eroded at the expense of the taxpayers in their countries. Tax collections increase with higher inflation and government debt becomes a smaller percentage of government revenue raised from taxes.

Who manages inflation and what instruments can they use?

Central banks have responsibility for containing inflation. They use the level of interest rates to contain inflation. This responsibility for containing inflation is most noticeable in countries that use inflation targeting. In these countries, central banks adjust interest rates in line with the rate of inflation and its expected future level to contain it to the target range.

To contain inflation, central banks must keep interest rates above the inflation. This difference between the rate of inflation and the interest rate is called the real rate). When the rate of inflation accelerates and is expected to continue this trend, the central bank’s policy response is a higher interest rate level (both nominal and real), commensurate with the change in the inflation trajectory.

What can go wrong?

Central banks can make wrong assumptions and use wrong projections in their assessment of future inflation. This can lead them to set interest rates at an inappropriate level. An example is the recent acceleration in the inflation rate in the US to a level above 8%. At an average of around 3% per annum, the US inflation rate was at a very low level for the last four decades). Recently the rate accelerated to above 8%, without an appropriate policy response by the US Federal Reserve.  As a result, US inflation could become a persistent problem.

This unexpected acceleration in prices caught US households by surprise. Many households (for instance pensioners) who assumed that inflation would remain under control, are now faced with much higher expenses without a commensurate increase in income. It is therefore important that central banks are constantly vigilant and respond to accelerating inflation. Inevitably, this implies setting interest rates at an appropriate real level above the rate of inflation.

The real rate of interest rates can be calculated in several ways. The simplest and easiest way to calculate is by deducting the rate of inflation from the nominal interest rate. Some African countries suffer persistent inflation problems, with rates much higher than in developed economies. The Zimbabwean inflation rate for the year to April 2022 accelerated to 96.4% , while Ghana’s inflation rate was 19.4% over the same period.

Countries suffering high inflation experience exchange rate pressure, with declining currency values. The exchange rate of the currency will remain under downward pressure as long as high inflation persists. Owing to high inflation, investment in the country becomes unattractive. The demand for the currency therefore declines, which puts the exchange rate of the country with high inflation under pressure.

The Ghanaian currency has already depreciated by 18% against the US dollar this year. A further value decline is expected for the rest of this year. Over the past year, the Zimbabwean RTGS dollar has lost more than half its value against the US dollar). Owing to sharp currency depreciation, the domestic prices of imported goods and services in countries like Ghana and Zimbabwe have increased sharply and continue to increase each time the currency depreciates. Consumers in those countries who earn income in local currency experience increasing difficulty to afford imported goods and services.

The trust deficit

A problem in an environment of sustained inflation is that people do not trust the official published rate of inflation. Inflation rates are distrusted for several reasons. The first is a general distrust of government conduct. This results in a view  that inflation rates are manipulated by government agencies responsible for their publication to report lower price increases than is actually the case.

Secondly, increased prices for goods such as fuel that receive considerable publicity, lead to perceptions of general price increases. This problem is linked to the fact that price increases are much more visible to consumers and attract more attention than price declines.

Lastly, inflation measures price increases on a cumulative basis, using each previous year’s price level as the base for calculations. This implies that each previous year’s inflated price level is used to measure the rate of inflation in the next year. Over time the cumulative effect of sustained inflation becomes quite large.

This can be explained in a different way. With a sustained inflation rate constant at 5% per annum, the intuitive perception is that prices will double every 20 years. In practice, however, under these conditions, prices will double every 14.4 years. Price increases therefore exceed the perceptions of consumers. Given the negative impact of inflation, it is in the interest of all consumers that the authorities should always apply policies that prevent price increases or keep such increases to a minimum level.

Inflation does not make people wealthy, despite the fact the governments and borrowers enjoy benefits from inflation. Which is why the description that inflation is public enemy number 1 is so accurate.

Jannie Rossouw  is a visiting Professor at the Business School, University of the Witwatersrand

Courtesy: The Conversation


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BUSINESS & ECONOMY

A Labour Government Should not Frighten the Horses

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The UK general election is likely to mean changes, but Gulf citizens need not be too worried.

By James Drummond

If the tension was killing you, now you know. If it wasn’t, then be aware that a general election in the United Kingdom will be held on July 4 – less than six weeks away.

For the hapless Rishi Sunak, it looks like a case of “If it were done when ’tis done, then ’twere well it were done quickly.” Polls indicate that after 14 years of conservatism, real or imagined, voters are likely to elect a new Labour government.

What does this mean for us here in the Gulf?

The six Gulf states are certainly exposed to Britain. The extent of GCC holdings in the UK is enormous, ranging from Qatari ownership of the Shard building in London, stakes in the Sainsburys supermarket chain and Barclays bank, to Sheikh Mohammed bin Rashid’s Godolphin stables in Suffolk.

Manchester City and Newcastle United football clubs are owned by Emirati and Saudi interests, respectively. Kuwait’s wealth is managed by the Kuwait Investment Office near St Pauls Cathedral.

Labour has been careful to detail very few policies (or hostages to fortune, as its strategists may see it), but last week, David Lammy, the likely new foreign secretary, outlined a further campaign against dirty money.

Britain is a “corruption services centre”, while London is a “hotbed of kleptocracy”, Mr Lammy said. He said that he wanted to reward whistleblowers and clamp down on “enablers” of financial crime.

Given the paucity of public announcements, Lammy’s speech is significant, because it implies that the incoming government is likely to act. Fighting financial crime is relatively uncontroversial and attracts cross-party support – although in the UK’s case with limited success.

British politicians have made similarly grandiose statements before. But after Russia’s invasion of Ukraine, London has moved particularly against Russian dirty money, and sanctioned individuals. It finally introduced an obligation mandating the disclosure of beneficial owners of property.

Overseas trusts are also now required to disclose their ultimate beneficial owners, and there is now greater transparency when registering entities at Companies House.

This seems to have had only limited effect, however. Last week Andrew Mitchell, the deputy foreign secretary, cited estimates that 40 percent of the world’s dirty money still passes through London.

Spotlight on Corruption, a non-governmental organisation, wrote in October last year that “major reform is needed to how lawyers and accountants, the property sector and company formation agents are regulated for money laundering.” Lammy may choose to take further action against these and other professionals.

Other so-called enablers include retired politicians, some of them in the House of Lords, who work as advisors to unsavoury actors. Labour could move to tighten disclosure, although several of its senior former members are likely to lobby against further transparency.

It is also possible that Labour will go further in taxing expatriates. In its limited public commitments, the party has promised to clamp down on “tax dodgers”.

Those with property in the UK already pay tax on rental income they receive, and worldwide assets are subject to Britain’s inheritance tax. Some Gulf Arab families with UK property have been caught by inheritance tax.

A government led by Sir Keir Starmer, the Labour leader, could go further, as the US does, in taxing worldwide income of its citizens, more than 200,000 of whom live in the UAE alone. The argument is that if you have the privilege of carrying the passport, you have an obligation to pay tax.

Another question surrounds nationalisation. Labour is committed to re-nationalising the railways for one, although the infrastructure is already under central government control.

But another target may – may – be England’s water supply network, which was privatised in 1989. Shareholders in various of the rump companies include the Qatar Investment Authority and Adia of the UAE.

The water companies have been the subject of a vociferous campaign, for allegedly paying their shareholders high dividends while neglecting maintenance and investment. It is possible that an incoming Labour government will nationalise the industry.

All that said, the primacy of the rule of law and respect for property rights remain strong in Britain.

Barratt, a mass housebuilder, reported earlier this week that London remains the top choice among world cities for UAE investors looking to buy overseas. The holdings of Gulf states and rights of Gulf citizens in the UK remain secure, even with a Labour government.

James Drummond is Editor-in-Chief of the AGBi

Courtesy: The AGBI.Com


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Kuwait’s Political Crisis Adds to Economic Uncertainty

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Kuwait’s latest standoff is deeply concerning for both the near and long term, writes Andrew Cunningham

The decision by Kuwaiti emir Sheikh Mishal Al-Ahmad to dissolve the country’s recently elected parliament just days before its inaugural session on May 14 presents overseas investors and Kuwaiti citizens with more uncertainty.

The situation raises concerns about the country’s economic prospects over both the short and long term.

Disputes and stand-offs between Kuwait’s emirs and its boisterous parliament are nothing new. Parliament has been dissolved, and the constitution suspended, numerous times over the past 40 years. The country has held four elections in the past four years.

Squabbling between the two sides is rooted in political disagreements and this most recent outbreak is no different.

A major factor behind the latest dissolution is believed to have been parliament’s objection to Sheikh Mishal’s choice of crown prince. Although the crown prince is nominated by the emir, the appointment has to be ratified by the parliament.

But these political, and sometimes personal, disputes have real consequences for Kuwait’s economy and financial system and, ultimately, for the long-term welfare of its citizens.

Kuwait is a prosperous country. If we take a snapshot today, we see it producing nearly 2.5 million barrels of oil per day (bpd), and there are plans under way to increase production capacity to 4 million bpd by 2035.

State foreign reserves are around $930 billion, according to National Bank of Kuwait, the country’s largest bank. With a population of a little over 4 million, its GDP per capita is one of the highest in the world.

Squabbling between the two sides is rooted in political disagreements and this most recent outbreak is no different.

A major factor behind the latest dissolution is believed to have been parliament’s objection to Sheikh Mishal’s choice of crown prince. Although the crown prince is nominated by the emir, the appointment has to be ratified by the parliament.

But these political, and sometimes personal, disputes have real consequences for Kuwait’s economy and financial system and, ultimately, for the long-term welfare of its citizens.

Kuwait is a prosperous country. If we take a snapshot today, we see it producing nearly 2.5 million barrels of oil per day (bpd), and there are plans under way to increase production capacity to 4 million bpd by 2035.

State foreign reserves are around $930 billion, according to National Bank of Kuwait, the country’s largest bank. With a population of a little over 4 million, its GDP per capita is one of the highest in the world.

In March this year, rating agency Fitch described Kuwait’s fiscal and external balance sheets as among the strongest of any of the governments it rates.

But when we look at long-term trends, the picture is more complex and less secure.

Kuwaiti government spending remains overwhelmingly dependent on oil and gas revenues. The government has made almost no progress, over many decades, in diversifying the economy away from oil, or in reducing the huge burden of government salaries and welfare payments.

Oil and gas revenues currently account for nearly 70 percent of total income and, according to IMF projections, will continue to do so for the rest of the decade.

These revenues have served the country well in the past, despite the volatility of oil prices, but such overwhelming dependence looks foolhardy when consumers worldwide are striving to reduce consumption of oil and gas and investors and energy firms have pivoted towards renewables.

Nearly all of the Kuwaiti government’s non-oil and gas revenue arises from overseas investments and from dividends from state-owned companies. Tax revenues account for less than 1 percent of total government income.

Looking beyond the fiscal imperative to diversify the economy is the need to provide employment opportunities for Kuwaiti citizens.

No less than 84 percent of the Kuwaiti workforce was employed by the government at the end of 2022. It is hardly surprising that nearly half of government expenditure is allocated to the salaries of public employees.

Pressure for social spending will increase in the years ahead. A World Bank report, published last year, showed that levels of obesity and Type 2 diabetes were higher in Kuwait than in any of the other GCC countries and nearly double the average in OECD countries.

Partly as a result of this, the World Bank estimated that Kuwait’s old age dependency ratio – the number of people over 65 years old in relation to those of working age – will be nearly double that of its neighbours by 2040.

Kuwait is also a country that is being significantly affected, even today, by climate change. Temperatures during the summer can exceed 50 degrees, making Kuwait one of the hottest places on earth.

These are difficult and complex challenges, both economic and social, but they are hardly unique to Kuwait. That they are, in some cases, more acute in Kuwait than elsewhere is due to decades’ long procrastination and political paralysis.

The government’s General Reserve Fund, which held most of its liquid assets, was entirely depleted in September 2020, according to Kuwait’s own ministry of finance. With AA ratings, the obvious solution was to borrow money – Kuwait’s debt-to-GDP ratio is less than 5 percent. Yet the parliament has still not passed a so-called ‘Liquidity Law‘ that would allow modest issuance of foreign currency debt.

The parliament also held up the introduction of Value Added Tax (VAT), making Kuwait one of two of the six GCC countries not to fulfil a joint commitment to implement a minimum VAT of 5 percent.

Over the past four years, all three of the big international credit rating agencies have downgraded the government of Kuwait.

In their rating reports, all agencies cited a dysfunctional and slow-moving political environment that was reducing the country’s financial flexibility and delaying much needed economic and financial reform.

Politics matters.

It is unrealistic to think that after decades of enmity the ruling family and the parliament will soon form a harmonious working relationship.

But they do need to find some common ground that will enable them to start addressing fundamental economic and social issues while the country still has large financial reserves and strong credit ratings.

Time is running out.

Andrew Cunningham writes and consults on risk and governance in Middle East and sharia-compliant banking systems


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ICD and JSC Ziraat Bank Collaborate to Boost Uzbekistan’s Private Sector

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At the 3rd Tashkent Investment Forum, the Islamic Corporation for the Development of the Private Sector (ICD) and JSC Ziraat Bank Uzbekistan took a significant step forward in their partnership to empower small and medium-sized enterprises (SMEs) and foster economic growth in Uzbekistan. The forum, held in the capital city of Uzbekistan, brought together key stakeholders from the public and private sectors to discuss investment opportunities and economic development strategies for the region. The collaboration between the Islamic Corporation for the Development of the Private Sector (ICD) and JSC Ziraat Bank Uzbekistan is aimed at boosting the private sector in Uzbekistan.

During the forum, ICD and JSC Ziraat Bank Uzbekistan formalized an expression of intent to collaborate on various initiatives aimed at supporting SMEs. One of the key elements of this collaboration is the provision of a Line of Financing (LoF) facility by ICD to JSC Ziraat Bank Uzbekistan. This LoF facility will enable the bank to fund private sector projects as an agent of ICD, thereby providing SMEs with access to the necessary capital to initiate and grow their businesses.

The partnership between ICD and JSC Ziraat Bank Uzbekistan is expected to have a significant impact on the SME landscape in Uzbekistan. By equipping entrepreneurs with the resources they need to succeed, this collaboration will not only support the growth of individual businesses but also contribute to the overall economic development of the country. SMEs play a crucial role in driving economic growth, creating jobs, and fostering innovation, and this partnership will help strengthen the SME ecosystem in Uzbekistan.

JSC Ziraat Bank Uzbekistan, as a strategic partner for ICD, brings a wealth of experience and expertise to the table. As a prominent commercial bank with foreign capital, JSC Ziraat Bank Uzbekistan has a strong track record of supporting SMEs and promoting economic development. The bank’s partnership with ICD further underscores its commitment to advancing the private sector in Uzbekistan and its dedication to supporting the country’s economic growth.

ICD, for its part, is a leading multilateral development financial institution that focuses on supporting the economic development of its member countries through the provision of finance and advisory services to private sector enterprises. By partnering with JSC Ziraat Bank Uzbekistan, ICD is furthering its mission of promoting economic development and fostering entrepreneurship in Uzbekistan and across the Islamic world.

The LoF facility provided by ICD to JSC Ziraat Bank Uzbekistan is just one example of the many initiatives that the two entities are undertaking to support SMEs in Uzbekistan. In addition to providing financial support, the partnership between ICD and JSC Ziraat Bank Uzbekistan will also include capacity-building initiatives and technical assistance programs to help SMEs succeed in today’s competitive business environment.

Overall, the partnership between ICD and JSC Ziraat Bank Uzbekistan represents a significant step forward in supporting SMEs and fostering economic growth in Uzbekistan. By working together, these two institutions are helping to create a more vibrant and dynamic private sector in Uzbekistan, which will ultimately benefit the country’s economy and its people. The collaboration between the Islamic Corporation for the Development of the Private Sector (ICD) and JSC Ziraat Bank Uzbekistan is expected to have a far-reaching impact on the private sector in Uzbekistan.


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