Qatar’s policy crisis
Qatar is currently facing a serious crisis on its economic policy-making. Qatar has lost its monetary policy independence in mid-1980, when it decided to (de facto) peg its currency to the US dollar. The de facto peg has become de jure in 2001. With the loss of its monetary policy as an effective economic policy instrument, Qatar has recently compromised its fiscal flexibility by committing to host the 2022 FIFA world cup. This is because to finance the required infrastructural development for the world cup, Qatar will have to undertake periods of expansionary fiscal policy. Hence, Qatar’s fiscal policy will remain inflexible in the sense that, if needed, policymakers will not be able to reduce government spending as a possible way to fight potential future inflation.
The US dollar has been weak, and is likely to continue to be weak against major vehicle currencies. This implies that the value of the Qatari riyal will also be weak against major international currencies. This is a major concern for Qatar as it heavily depends on imported goods and services. A weaker domestic currency implies higher import bills. Qatar’s demand for imports (particularly construction materials) will increase to satisfy additional raw materials needed to build infrastructure for the 2022 world cup. Meanwhile, global food prices has been rising. Therefore, with an unfavorable external conditions (eg, weakening US dollar, rising global prices) and a constrained domestic environment (eg, inflexible fiscal and monetary policies), Qatar will face many challenges to maintain a stable economy.
One of the challenges is “rising” future inflation. Compared to 2010, Qatar’s inflation rates during 2011H1 have been much higher, especially nontradable inflation rate (excluding rent). So, what can Qatar do keep (future) inflation under check? Let’s begin with the possible options related to the fiscal policy. As mentioned, future fiscal stance will remain expansionary to support spending to prepare for the 2022 world cup. Since fiscal tightening is not a policy option, Qatar can explores areas in which it can eliminate unnecessary spending. For example, some planned mega projects are based on implausibly high population growth projections (eg, plans to extend roads and metro network) or unrealistically cargo-traffic volume expectations (eg, plans to construct new seaport). For mega projects like these, the potential for building overcapacity is strong. A lot of money can be saved by delaying capacity additions until real demand materializes.
Further, instead of using petrodollars to finance infrastructure projects, Qatar can alternatively raise money through issuing longer maturity (sovereign) local currency bonds (LCBs). I have argued here before, LCBs will help to mop up surplus liquidity that would otherwise fuel inflation. With very little institutional support, the nation’s central bank can use these LCBs for liquidity management, partially offsetting the loss of its monetary policy independence.
Whilst Qatar lacks the freedom to use interest rate as a policy instrument to slow money growth, other alternative measures can be used to deal with surplus liquidity. These include foreign exchange swaps, further raising the reserve requirement, optimal usage of the standing facilities, and selective capital controls (especially those involving financial FDI). While these options deserve further consideration (which I have discussed in a forthcoming co-authored working paper), they have been proven effective in dealing with surplus liquidity in other countries, including some GCC countries.
Today’s Qatari economy is more sophisticated than 1980s, but sadly its economics policies still have not managed to upgrade. Qatar doesn’t have a proper macroeconomic stabilization policy framework that can steer the economy through difficult times. Fortunately, things have begun to move. Qatar’s first ever five-year plan (dubbed “Qatar National Development Strategy 2011-2016”) recognizes the need to modernize its economic policies, though it remained silent on the efficacy of its age old pegged exchange rate system. With an improved monetary policy operational framework and a proactive exchange rate management, it will be much easier for the Qatari authorities to face the economic challenges of the coming decade.