Page 60 - Aamir Rehman Gulf Capital and Islamic Finance The Rise of the New Global Players

CHAPTER 1 Floating on Wealth 45

FIGURE 1.7

Gulf Decision Makers Have Severe Constraints regarding Economic
Policy

Monetary Policy Fiscal Policy

• Government investment has
• Dollar peg remains firmly in a degree of flexibility,
place in all countries but particularly with regard to large
Kuwait projects
• Maintaining the peg is • State benefits are quite
important for both economic inelastic because of expectations
and political reasons and pressures
• Effect of peg is that the • Income tax is largely absent,
Gulf’s interest rates are although fees and other
effectively set by the mechanisms are used to
United States and driven by generate supplementary
US domestic needs income

Key Driver Is the US Key Driver Is the Global
Federal Reserve Energy Market

constraints. In the realms of both monetary and fiscal policy, Gulf
states today have certain limitations on formulating policy responses
to economic crises. Figure 1.7 illustrates some of the key limitations.
Because all GCC currencies, with the exception of the Kuwaiti
dinar, remain pegged to the US dollar, the region’s scope for
autonomous monetary policy is extremely limited. Interest rates are
de facto set by the US Federal Reserve, which makes its decisions
based on the state of the US economy, not on the needs of the GCC.
Over the years, many have cited the dollar peg as a root cause of high
inflation in the Gulf. Rapid economic growth in the GCC would oth-
erwise have dictated higher interest rates to curb inflation, yet the
dollar peg kept interest rates low. The dollar peg cannot, however, be
entirely to blame for Gulf inflation, as inflation is a natural by-product
of the dramatic growth in the region’s wealth. There has been much
discussion about shifting away from the dollar peg, and much of the
thrust behind the envisioned GCC monetary union was to enable
greater autonomy in Gulf monetary policy. As discussed in Dubai & Co.,