A whiff of stagflation?

Posted on May 19, 2011

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Sluggish economic growth. Slow job creation. Galloping inflation. What’s the verdict?

The classical definition of stagflation involves stagnation in economic growth and employment numbers coupled with persistently high inflation. It would occur when a nation’s output is not increasing but prices are. Stagnating economic growth results in fewer jobs being created, which in turn restricts consumer spending. This feeds the vicious cycle as decreasing consumer spending results in lower production and impacts GDP growth even further. At the same time, however, prices continue to increase.

Does this ring any bells given the current global economic situation? GDP growth appears to be plateauing in most major economies, although the encouraging aspect is that expansion continues. Job numbers are a concern, especially in the US, where the most recent data indicate that more people were fired than hired. And commodities look like they will continue their bull run after the breather of the past two weeks.

The economies of the MENA region paint a similar picture. New forecasts by Bank of America Merrill Lynch show inflation at 5.5% will outstrip GDP growth of 4.9% in the Saudi economy this year. Egypt’s prices are expected to grow at 12% compared to GDP expansion of just 1%. Bahrain may witness 3% inflation compared to a 2.2% contraction in the economy. The corresponding numbers for Kuwait are 4% inflation and 3.1% GDP growth. Nations with a reverse trend include Qatar and Oman, while the UAE has a more balanced forecast.

Most central banks have remained ahead of the game by tightening monetary policy to choke off inflation. Unfortunately, that also makes it more expensive to finance economic growth. Bottom line: global economies seem to be on a knife-edge, where they will remain as long as commodity supply fears keep prices at unsustainable levels. This will also sustain uncertainty in equity and currency markets as investors wait for a clear trend to emerge.

The increase in commodity prices – especially crude – appears to be driven more by expectations of supply disruptions due to the unrest in some producer nations than by an actual demand-supply gap. Speculative trading has also added fuel to the fire.

There is, however, an upside to the commodity price spiral for the Gulf oil providers. High crude revenues provide more impetus for economic growth. And, for the past decade or so, these nations have been using the revenue surge to invest in their own economies as opposed to simply buying up foreign assets. A more focused use of the opportunity – to create jobs and meet the aspirations of a better educated and more involved young population would help.

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Posted in: Economy