Beyond Band-Aid Measures: Addressing inflation

Inflation is a pressing challenge facing the Middle East and requires comprehensive economic reforms to tackle its root causes

May 11, 2023 - 3 minute read

The Middle East is facing a challenging economic environment marked by a confluence of factors, including the Russia-Ukraine war, the Covid-19 pandemic and volatile oil prices. One of the most immediate challenges in the region is inflation, the underlying causes of which have contributed to shortages of goods, rising commodity prices, plunging currencies and severe economic turmoil. These, in turn, have increased poverty, unemployment and social unrest, highlighting the need for sustainable solutions that address the situation and promote economic growth and stability.


Uncovering the root causes of inflation

One of the main drivers of inflation is the continued reliance of countries across the region on oil revenues, which has led to a significant lack of economic diversification. Oil-export-dependent economies have been negatively affected by the sharp decline in oil demand caused by the pandemic. Disruptions to supply chains in the wake of Covid-19 and amid the Russia-Ukraine war coupled with the depreciation of local currencies against the US dollar have increased the cost of importing goods and created shortages in the local markets, further fuelling inflation. Furthermore, a decrease in production following the imposition of lockdowns and other pandemic-related measures has led to an imbalance in the supply and demand for goods and services, driving up prices more.

The nature of inflationary challenges varies between countries due to differences in economic structures, political stability and external factors such as global commodity prices. Egypt is heavily reliant on imports and faces high inflation rates due to a shortage of foreign exchange reserves. In contrast, the Gulf countries have more diversified economies and access to significant oil revenues, which can mitigate the impact of inflation.

Elsewhere, instability and conflict have contributed significantly to inflationary pressures. The war in Yemen, for example, has caused a significant increase in the cost of living in the country due to disruptions to food and medical supply chains. In Syria, sanctions have devalued its currency and limited the availability of essential goods, including medicine and medical equipment.


Road to Recovery: Adopting effective monetary and fiscal policies

Although the inflationary pressures and economic challenges between countries vary, what matters is that those that can take decisive action towards meaningful economic reforms that tackle the issue head-on.

One essential step involves strengthening monetary policies. Central banks should adopt prudent measures such as interest rate adjustments and exchange rate management to regulate the money supply and prevent currency devaluation. Governments can also adopt effective fiscal policies to better manage budget deficits and curb inflationary pressures. These include reducing subsidies and improving tax collection mechanisms.

Prioritising social safety nets is another important step, as moves such as providing targeted subsidies for basic necessities, healthcare and education, and implementing welfare programmes to support low-income families can not only alleviate the burden of inflation on vulnerable populations but promote social cohesion.

For instance, subsidy cuts in Egypt, aimed at addressing high inflation rates, have had a significant impact on the cost of living, particularly for low-income households. Recent increases in fuel prices have particularly affected the most vulnerable segments of society, with transportation and basic goods becoming more expensive. To mitigate these effects, the government has implemented social protection programmes, such as cash transfers and food subsidies. However, these programmes require substantial resources and effective targeting mechanisms to ensure they reach those most in need.


Catalysts of Lasting Change: Building sustainable economies

Strengthening monetary policies and implementing social safety nets will lessen inflationary pressures and ensure a better future for the region’s citizens, but if countries are to address the root causes of inflation, building resilient and sustainable economies that are not solely reliant on oil revenues is key.

In order to achieve this, governments need to implement economic reforms that focus on developing non-oil sectors, such as manufacturing, tourism, technology and agriculture, and invest in education and innovation to foster entrepreneurship and promote job creation. Encouraging private sector growth and entrepreneurship by providing incentives for businesses to invest in their countries also increases employment opportunities, and economic growth and development.

Enhancing transparency and accountability and ensuring efficient resource allocation are crucial aspects of this process that remain a significant challenge across the region. Corruption and opaque practices in government and business deter private investment while funds allocated to infrastructure and public services are sometimes diverted to inefficient projects, setting back social development.

In the UAE and Saudi Arabia – two regional leaders in supporting the development of non-oil sectors such as renewable energy, tourism and knowledge-based industries – governments are the primary investors in new projects in many cases, limiting competition and deterring foreign investment. The dominance of state-owned enterprises and a lack of transparency in the business environment, including in the allocation of public funds and state-owned enterprise management, make foreign investors wary.

Mindful of this, both the UAE and Saudi have plans to improve transparency and accountability. The UAE, in particular, has taken concrete steps by establishing anti-corruption agencies and laws on corporate governance and transparency. By creating an environment that fosters competition and attracts private investment, Gulf states will be better positioned to address the root causes of inflation.