Gulf states in a fix over tumbling dollar

KUWAIT CITY - Oil-rich Gulf Arab states hit by high inflation are under pressure to revalue their currencies or drop the peg to the flagging US dollar, but de-pegging will come at a cost, analysts say.

By (AFP)

Published: Mon 17 Mar 2008, 6:35 PM

Last updated: Sun 5 Apr 2015, 1:19 PM

The widely anticipated new rate cut by the US Federal Reserve will intensify the debate about the peg, as it will become increasingly difficult for monetary decision-makers in the region to match successive cuts, experts told AFP.

“I think these countries can’t keep ignoring the weakness of the US currency and the repeated interest rate cuts,” said a former chief of the Kuwait Investment Authority, Ali al-Bader.

“They have either to peg to a basket of currencies... or gradually revalue their currencies, otherwise the cost will be too high,” he added.

Kuwait was the only member of the Gulf Cooperation Council (GCC) to drop the dollar in favour of a basket of currencies last May. Since then the Kuwaiti dinar has appreciated about 7.7 percent against the greenback.

The remaining GCC states -- Bahrain, Oman, Qatar, Saudi Arabia and the United Arab Emirates -- have so far shrugged off calls for an adjustment to their exchange rate regime, saying it would harm their economies.

The policy of pegging local currencies to the dollar enhanced monetary stability and benefited domestic economies when the US and Gulf economies were heading in the same direction.

Now, Gulf economies are growing at a rapid pace spurred by an unprecedented oil windfall, while the US economy is on the verge of recession as a result of a weak dollar, high energy prices and a liquidity crunch.

High growth in Gulf states has resulted in high, sometimes double-digit, inflation rates.

The divergence began when the United States started cutting interest rates in September in a bid to stimulate its stagnant economy.

The Fed has already slashed its federal funds rate, the base rate for interbank lending, to 3.0 percent from 5.25 percent in September and another cut is expected on Tuesday.

Most Gulf countries were forced to follow the US cuts to ward off speculation on their currencies, although rate rises were needed to fight rising inflation.

Saudi Arabia, for example, cut its reserve repo rate -- the interest paid on deposits -- from five to three percent.

But it maintained the main repo rate -- the interest taken on loans -- at 5.5 percent in a bid to discourage lending and curb inflation which hit seven percent in January.

“Maintaining the dollar peg means higher inflation rates and eventually GCC governments have to compensate that with salary raises,” which most of them have already done, Bader said.

Kuwaiti economist Amer al-Tameemi said GCC states “don’t have too many options” regarding the dollar peg.

De-pegging is “an extremely difficult matter, taking into consideration that a majority of their deals are in dollars”, Tameemi, former chairman of the Kuwait Economic Society, told AFP.

Huge oil revenues are priced in dollars and mammoth foreign investments, estimated at close to 1.5 trillion dollars (960 billion euros), are mostly quoted in the US currency.

Kuwait’s opting for a basket of currencies was a “mere formality since the dollar makes up a major component of the basket”, Tameemi added.

The measure failed to curb inflation which reached 7.3 percent in September.

Former Federal Reserve chairman Alan Greenspan advised Gulf Arab states to float their currencies as a means to curb inflation during a visit to the region last month.

But UAE central bank governor Sultan bin Nasser al-Suwaidi rejected the advice.

Tameemi however agreed that “currency flotation is the best solution now”, though this should be accompanied by investment diversification to alleviate the dangers of the weak dollar.

Saudi Jadwa Investment said in a report that the cost of de-pegging outweighs maintaining the current exchange rate regime, but acknowledged that GCC currencies will continue to feel pressure from US Fed interest rates cuts.

Many economists see inflation as mostly homegrown and the result of high oil prices.

“If we want high oil prices we should not worry about the (high) price of tomatoes,” a senior manager of Kuwait’s Commercial Bank, Abdulmajeed al-Shatti, told a seminar last week.

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