Stronger GCC currencies set to ease inflation in 2017: Citi

Eduardo Campos Martinez, Global Head of Investments, Citi Private Bank, addressing a Press conference on the 2017 Citi Investment Outlook in Dubai on Tuesday.

GCC currencies that are pegged to the dollar are poised to strengthen in 2017 on the back of an appreciation of the greenback, resulting in lower inflationary pressures as the imported basket of consumption will see price deflation, Citi Research said.
Economists at Citi Research forecast a 10 per cent appreciation of the dollar against the euro, partly due to the expected fiscal stimulus and rising rates under a Trump administration.
"With the (partial) exception of the Kuwaiti dinar, GCC currencies are pegged to the dollar, meaning that these too will strengthen in 2017. Although the immediate impact of this is arguably near term positive, it is not entirely so," Citi said in its Middle East Economic Outlook.
The report argued that a strengthening currency reduces the cost of imports, thereby strengthening the terms of trade. "This reinforces the impact of rising oil prices, which has helped the terms of trade improve by 61 per cent since the start of the year."
By the end of 2017, the strengthening dollar should see GCC terms of trade improve by almost 90 per cent relative to their nadir in January of this year (but still over 50 per cent down from its peak in June 2014), said the report.
"Strengthening terms of trade are generally a good thing for an economy as they imply a higher standard of living and stronger economic growth, particularly where economic inputs are largely imported. They also imply lower inflationary pressures as the imported basket of consumption will see price deflation," economists explained. In the GCC, where a large percentage of domestic consumption is import-dependent, this effect is significant.
"On the other hand, a strengthening in the terms of trade may not be such a good thing in the context of efforts to diversify GCC economies. A stronger currency erodes competitiveness, for example, which will have a negative impact on non-oil exports such as tourism, a major pillar of the economy in Dubai and Oman," the report said.
Stronger currencies hinder inward foreign direct investment flows as operating costs for foreign companies rise. "Finally, it dampens incentives for import substitution, reducing the viability of nascent domestic industries which have to compete with cheap foreign imports," economist at Citi argued in the report.
All of these are potentially negative for GCC economies as they seek to grow the private non-oil sector. "Either way we do not foresee any changes in GCC foreign exchange policy in 2017. That is not to say pressure will not build on the pegs during this time."
The research argued that there are downside risks to oil prices that could renew speculation, for example, or capital outflows could accelerate in an environment of tighter US monetary policy.
"Also, a new theme that may emerge in 2017 is the need for greater monetary policy independence in the GCC given the rising divergence between the US business cycle (where growth is accelerating along with inflationary pressures) and the GCC cycle (where it is decelerating). This was a key driver behind peg speculation in 2007-08," economists said.
- issacjohn@khaleejtimes.com