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Kuwait ends currency peg to US dollar

Ending months of speculation, Kuwait yesterday abandoned its four-year old currency peg to the US dollar in a move that is expected to trigger renewed calls from monetary experts in the UAE and other GCC countries — reeling under imported inflation resulting from a tumbling greenback — to follow suit.

The Kuwaiti Central Bank's move to switch the dinar exchange rate mechanism to a basket of currencies, although aimed at softening its spiralling domestic inflation, is feared to further delay the GCC monetary union which is already poised to miss the 2010 deadline, analysts said.

Kuwait, the third-largest Arab oil producer, ditched the dinar's peg against the dollar in favour of a basket of currencies, which it abandoned in 2003 to prepare for the GCC monetary union. While the move, as predicted yesterday by Khaleej Times, was long expected to stave off the negative impact of a declining dollar, it caught markets and fellow central bankers unawares.

Welcoming the move as heralding a new era in GCC monetary policy, a Dubai-based economist said other countries in the region which are suffering from their alliance to a sliding dollar should start moving in the same direction.

Shaikh Sultan bin Saud Al Qassimi, Chairman of Capital Industries Investment and Barjeel-Geojit Securities, speaking to Khaleej Times from London, described the Kuwait Central Bank move as wonderful. "It is time the UAE start switching its currency peg away from the dollar to a basket of currencies. We have been undecided about this for the past two years. As the dollar is expected to continue its slide for at least two years, we should move without further delay," he said.

Shaikh Sultan quoted a recent Deutsche Bank report indicating that should the de-pegging become a reality, the GCC currencies will appreciate anywhere between 10 and 30 per cent against the dollar. In 2006, thanks to Gulf currencies' dollar peg, their value fell by 22 per cent vis a vis euro, he pointed out. "When the Kuwait Central Bank allowed its currency just one point of flexibility last year, it appreciated to its highest level against the dollar since 1992." According to the bank, most of the GCC currencies are undervalued against the dollar, based on their current-account balances, inflation and costs of goods and services.

Following Kuwait Central Bank move, the dinar immediately strengthened against the dollar yesterday. According to reports, the move stunned Gulf currency markets and volumes dried up. "The impact would be clearer on Monday when international markets open," Steve Brice, chief Middle East economist at Standard Chartered Bank in Dubai was quoted by a news agency.

"The massive decline in the dollar's exchange rate against main currencies has contributed to the increase in local inflation rates and this step is part of the central bank's efforts to curb inflationary pressure," Shaikh Salem Abdul Aziz Al Sabah said in a statement carried by state news agency Kuna.

While Oman, Bahrain and Saudi Arabia said they planned to stand by their pegs, the UAE central bank could not reached yesterday for its reaction.

Kuwait's surprise move came in the wake of International Monetary Fund ruling out such a possibility until 2010. Last week in Dubai, Mohsin Khan, IMF director for the Middle East and Central Asia, told Khaleej Times that a depegging from dollar was not good for the region's financial stability. "We believe that it is inevitable that Gulf currencies to stay with the dollar peg until the currency union, which I have no reason to think not possible by 2010," he said. "Gulf states should not alter their currency pegs, which will do little to curb inflation and might threaten perceptions of Gulf currencies as stable," he said.

However, Kuwait's central bank governor said his country was still committed to monetary union and was only acting in the "national interest" to contain inflation. "Until the completion of all the requirements to achieve the currency union and the launch of the Gulf currency, the Central Bank of Kuwait will continue to adopt the basket system." The statement did not say what currencies were in the basket.

On Saturday, Kuwait's Finance Minister Bader Al Humaidhi hinted out that it is considering revaluing its dinar and is weighing the benefits of keeping the currency pegged to falling dollar. Kuwait’s currency has come under intense pressure from speculators betting the central bank would allow it to appreciate against the dollar to curb inflation and soak up some of the cash pouring into the oil exporter’s economy. Inflation has been running at 3-4 per cent in the past nine months compared with a historical average of less than two per cent, Deutsche Bank said in a note last week.

Kuwait has blamed rising inflation on the falling dollar, which tumbled to a record low against the euro in April.

On May 12, Kuwait cut its repurchase rate for the second time in six weeks on Sunday in what appeared to be its latest move to deter speculators betting on an appreciation of the oil exporter’s dollar-pegged dinar currency.

The Kuwait's central bank has spent the past six weeks defending the dollar peg as it came under pressure in the runup to an April central bankers meeting to try to revive the monetary union plan. The talks ended inconclusively.

However, some other analysts said Kuwait's decision to de-link dinar from dollar should not be taken as a sign of things to come elsewhere in the GCC.

Kuwait in 2003 became the last of six Gulf Arab monarchies including Saudi Arabia to peg its currency to the dollar in readiness for a single currency planned for 2010. The Kuwaiti dinar is trading at the top of a 3.5 per cent permitted band set when the dollar peg was established in January 2003.

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