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Gulf states can't cut inflation with revaluation

Saudi Arabia, the United Arab Emirates and other members of the Gulf Cooperation Council will consider relaxing their fixed exchange rates after the US currency fell to a record low against the euro this month. The group, which includes Bahrain, Oman, Qatar and Kuwait, is scheduled to meet in Qatar December 3-5.

Rising import prices caused by the falling dollar and higher revenue from this year's 49 per cent jump in crude oil have pushed inflation to a five-year high in the region. Kuwait's rate of price increases held near a record 5 per cent since the nation dropped the dinar's peg to the dollar in May.

"Revaluation wouldn't be a cure for inflation," said Simon Williams, an economist at HSBC in Dubai. It will only provide temporary relief to the 'symptoms,' he said.

The GCC members are limited in fighting price increases because their pegs to the dollar force them to mimic the monetary policy of the US Federal Reserve, which lowered interest rates twice since mid-September. The UAE Economy Ministry published an advertisement in a section of Press on November 26 asking businesses to 'avoid all forms of exploitation and monopoly leading to an unjustified increase in prices.'

Restricting demand: "We believe policy makers will have to start thinking about demand management," Mushtaq Khan, an economist at Citigroup in New York, said in a research note. "This will be unpalatable in view of the oil price boom, but in our view this would be the only credible way to stabilise these economies."

The Gulf countries supply 22 per cent of the world's oil. Prices reached a record $99.29 a barrel earlier this month. Saudi Arabia has earned about $206 billion on an annual basis from oil sales this year, according to government figures. The UAE will receive $60 billion and Qatar $19 billion.

The difference between the price of the Saudi riyal and the cost of buying it in a year using forward contracts has widened 10-fold since October as traders bet the kingdom will sever its 21-year-old link to the dollar, data compiled by Bloomberg show. Contracts to buy UAE dirhams in 12 months rose to a record 3.56 against the dollar on November 29.

Gulf states will consider currency policy at their annual summit in Doha, the group's secretary general, Abdul Rahman Al Attiyah, told reporters on November 17 in Riyadh. UAE central bank Governor Sultan bin Nasser Al Suwaidi said this month that his country may link the dirham to a basket of currencies that would consist mostly of dollars.

Record inflation: A revaluation would reduce the cost of imports from Europe, though it may do little to slow government spending because of rising oil-related revenue, the strategists said.

"As the primary cause of such inflationary pressures in the GCC is oil, not the US dollar, neither a euro peg nor a basket peg would be an obviously superior regime compared to a US dollar peg," Stephen Jen and Charles St. Arnaud, London- based strategists at Morgan Stanley, said in a November 21 research note.

"Inflation in the UAE and Qatar would have risen towards 10 per cent even if these currencies were pegged to the euro."

Inflation in Saudi Arabia, the largest Arab economy, rose to a record 4.9 per cent in September, while Qatar's rate surged 14.8 per cent on an annual basis in the first quarter. The UAE, which publishes the data annually, said prices rose 9.3 per cent last year, an all-time high. The country raised the pay of government employees 70 per cent last week.

Gulf states are unlikely to make any formal change to their currency policies when they meet, half of the 10 economists surveyed by Bloomberg News said. Four expect the GCC to allow independent monetary policies that include the possibility of abandoning the dollar pegs, while one sees the states committing to revalue in tandem.