Paying the premium

The oil boom has made the Gulf one of the best places to do business, but inflation is rapidly making it one of the most expensive.

Two subjects are guaranteed to elicit groans in Dubai. One is the huge volume of traffic that now clogs the city roads. The other is spiraling rents. Both threaten to make the Emirate a victim of its own success, driving away expatriates who once were lured in by promises of an easy-going, tax-free lifestyle.

Inflation is one of the few black spots, but it is growing fast. With the region’s main oil producing economies enjoying double-digit growth, upward pressure on prices is to be expected. But the disparity in regional living costs suggests other factors are at fault. Inflation in Saudi Arabia is running at 0.5 percent, while in Qatar and the U.A.E. it is closer to 8 per cent.

The cost of accommodation can vary hugely, Shortages of rental property are acute in the young cities of Doha and Dubai, but less of an issue in established urban centres of Saudi Arabia and Kuwait. The rate at which some cities are expanding is also driving inflation, with strains put on everything from construction materials to luxury goods. Price rises for imported goods are exacerbated by the weakness of the US dollar.

Managing this rapid expansion is key. “Inflation is not inevitable in high-growth economies, “says Standard & Poor’s sovereign analyst Luc Marchand. Kuwait provides a good example: Kuwait’s non-oil economy is more efficient than elsewhere because de state started earlier in developing a strong local construction industry and financial markets. Qatar, on the other hand, is starting virtually from scratch in construction and real estate.

Price inflation inevitably leads to wage inflation, as employers hike salaries in order to hold on to staff. Average pay packets in the GCC construction and financial industries leapt by 12.8 per cent respectively in the year ending 30 August, according to Dubai-based recruitment consultancy GulfTalent. Wages in Qatar rose most steeply at 11.1 per cent, followed by the UAE. at 10.3 per cent. Kuwait saw a rise of 8 per cent- close to the regional average - while Saudi Arabia, Bahrain and Oman were towards the lower end of the scale.

This in turn has perpetuated a vicious cycle, with companies passing on higher costs to consumers. In certain countries average consumer prices are expected to rise by as much as 8.5 per cent, while unofficial estimates are much higher.

Growing numbers of expatriates are talking of leaving. “A Survey we carried out one-and-a-half years ago suggested that 9 per cent of foreigners were thinking of quitting the UAE” says a GulfTalent analyst. “Some are looking at other countries in the region, where employers pay more – the likes of Saudi Arabia, for example - while others are simply going home.”

Competition is also raising salary expectations. Head-hunting and poaching are becoming more common, while restrictions on job-switching are being relaxed.

“Inflation is not inevitable in high-growth economies”

Luc Marchand, sovereign analyst, Standard & Poor's

“The significant growth in the number of recruitment firms covering the region, particularly focused on proactive headhunting and executive search, has brought a greater degree of transparency and efficiency into the labour market," says the analyst.

On the supply side, traditional sources of labour are drying up. The booming economies of Asia mean workers from the Indian subcontinent see fewer incentives to move to the GCC. Average salaries in India, a leading provider of skilled personnel, are raising by 14 per cent, according to human resources consultancy Hewitt Associates. Other global factors are at work. As the dollar has weakened, so have dollar-pegged Gulf currencies. Staff from the Eurozone tend to measure their incomes in home currency terms, driving up local salaries.

Legal Changes

Strict laws on hiring nationals are also pushing up wages. “While Saudi laws are more stringent, employers are used to deal with them and the population based is far broader, “says the GulfTalent analyst. “The UAE was lax and quotas were applied at industry or company level, whereas now nationalization is linked to function – all human resources and secretarial staff, for example, are required to be emiratis.”

Similarly, plans in Manama to tax employers on the basis of their expatriate employees, due to come into force in 2007, will also feed inflation. “We will just pass the costs on to clients,” says the head of a leading local construction firm.

Rising salaries are a cause and a symptom of inflation. No one is warning of 1970s –style stagflation, but the wage/price spiral is already a problem. “Bigger, more established firms with strong cash-flows can afford it, but small-to-medium-sized companies are finding the climate tough and margins are shrinking” says the analyst. “Some firms are even talking about relocating, from Dubai to Bahrain for example. There is also a danger the region could price itself out of markets such as non-energy-related manufacturing, where the job could be done more cheaply in India or Jordan. And functions within an industry, such as back-office work, will be done elsewhere.”

Despite these concerns, the Gulf still has much to offer. Rent increases should ease as new housing hits the market, and there has rarely been a better time to do business in the region. “Inflation is certainly an issue to keep a watch on, “says Marchand. ”But there are just so many compensating factors for GCC economies. On balance, they will surmount this short-term problem.”