There is one word that would make any one in the United Arab Emirates (UAE) uneasy, inflation. From the businessmen in dark suits to the cheerful older men sipping dark sweetened tea, the talk of town hovers around rising living costs and the impact inflation might have on the country’s bustling economy. Certainly, there is much to worry about. In its October 2006 report, the National Bank of Dubai clearly singles out high inflation rates as "the single largest risk to the UAE’s economy." Even though the Central Bank has repeatedly tried to reign in inflation rites at below 4 percent, there is still no "indication of a decline in price levels, especially rentals which is the single largest constituent of the consumer price index." In fact, the Central Bank Governor, Sultan bin Naser AI Suwaidi has moved to limit the scope of inflation and has put the rate at between 4 to 6 percent. Yet, what is clear is that inflation is a rising concern for both the authorities and the general public. The question that many ask is whether or not inflation will hinder the outstanding economic growth of the country.

According to a November 2006 report the UAE’s Ministry of Economy and Planning expected GDP to rise 23 percent in nominal terms and 10 percent in real terms in 2006. That would bring the total figure to $162.67 billion. On the other hand, inflation has also increased at an alarming rate, reaching 13.8 percent in 2006 and is expected to remain at 9.3 percent in 2007. While the economy is certainly not cooling down, inflation is remaining steadily high.

An important factor behind rising inflation rates is escalating rental costs of both commercial and residential buildings. Given the great role rental costs play in determining the consumer price index- they have a weight-age of 37 percent according to the Ministry of Economy- it is understandable that a recent rental price cap put forward by the Abu Dhabi Government for 2007 led analysts to revise their forecasts for the coming year. This is especially important since accelerated Abu Dhabi rent rates were a "key factor in rising inflation," according to Steve Brice, an economist at Standard Chartered. As Brice mentions, Abu Dhabi rent increases rose from 14.5 percent in 2005 to 36.6 percent in 2006, and this increases "accounted for over half the 13.8 percent price increase in 2006 for the whole UAE."

The price cap imposed on Abu Dhabi rental increases will likely lead to a sharper fall in inflation in the coming year. With the cap in place it is possible to have inflation rates drop to 7.3 percent from the predicted 9.3 percent for 2007. Yet, analysts caution that there is a difference between proposing a rent cap and actually implementing it. Dubai took a similar measure in 2005 when it set a 15 percent rent cap. That policy failed to curb rental increases as many landlords found loopholes that allowed them to evade the price caps. This allowed rent increases in the emirate to remain at above 20 percent.

One factor may be shortages in the labor force, constructive material and residential and commercial spaces within the UAE. The country’s jaw-dropping developmental projects have increased demand while "local construction companies and suppliers have not been able to meet these needs. As a result, the UAE has been forced to import many materials," said Dr Zahid, the Chief Economist at Riyadh Bank. Importing basic materials and the market forces of supply and demand have brought about inflation in many of the different sectors. This has impacted the overall economy as well.

Excess liquidity in the market is another key reason. The Central Bank has indicated that money supply rose 24 percent between January 2006 and June 2006. The broadest measure of money in circulation (M3) reached Dhs436.2 billion ($118.86 billion) by the end of June from Dhs351.1 billion ($95.67 billion) last year, according to the latest statistics published by the Central Bank. One factor behind the rising money supply is climbing oil revenues. Naturally, the presence of a lot of money within the economy moved to push up prices.

According to Steve Brice, "while a case can be made for higher interest rates in the UAE and possibly a stronger dirham, given extremely strong growth and still high inflation, the fact remains that the currency peg precludes this." The UAE Central Bank Governor has been very keen in pushing forth with a new GCC single currency. In making the case for the currency, due in 2010, the Governor has called for a floating currency. Brice believes that "the rationale for this view is so that the GCC can manage its monetary policy settings, rather than delegating it to the US Federal Reserve, which has resulted in the stopped clock phenomenon - interest rates are rarely appropriate for the region and then only by coincidence, not by design. However, we will have to wait until after 2010 for this to become a reality."

For the time being there is some room for optimism. A slowing down in the property market will have a positive impact on bringing down inflation as property prices are expected to climb down 20 to 30 percent in the next coming years. There is a strong feeling that the residential market is reaching its peak. Moreover, as development projects reach completion, there will additional capacity that will deal with market demands. The Egypt-based financial services company Prime Group, expects nearly 52,000 units to arrive in 2007 and an additional 63,000 by 2008. Brice, taking expected population growth rates intro consideration, states that there will be an "excess supply of 6,000 units in 2007 and 33,000 units in 2008." The excess of supply will certainly drive down prices.