Amid rising concerns over Standard and Poor’s downgrade of the US’ credit rating from AAA to AA+ and its impact on Gulf currencies, which have hitherto been pegged against the US dollar, the UAE and Bahrain have dismissed speculations about an imminent de-pegging happening any time soon. ?The peg of the dirham to the US dollar is steady and consistent,? the UAE central bank confirmed last month. A similar statement was released by Bahrain last week.
Not a good sign
However, a weakened US dollar isn’t good news for Gulf countries, which rely heavily on imports from emerging markets, as they would have to spend more for the same products and services, and could hike inflation in the region, ?The peg worked well in the past with a strong US dollar, helping to anchor the GCC [Gulf Co-operation Council] economies and keep inflation low. However, this will not be the case if the outlook for the US dollar is weak”, according to Monica Malik, chief economist at the EFG-Hermes Investment Bank in Dubai.
According to the International Monetary Fund, inflation in Saudi Arabia is forecast to reach 6% and in the UAE, 4.5%. Saudi Arabia and the UAE, respectively, are the first and second largest economies in the Gulf region.
Although de-pegging Gulf currencies from the US dollar might, at first look, seem like a wise step, such a move could hurt confidence in the stability of Gulf economies and could cause more harm in the long run. Faisal Hasan, Head of Research at the Kuwait-based Global Investment House said,”Gulf will not only be exposed to its currency dropping against other currencies it will also be exposed to cost push inflation as well. The downgrade will undoubtedly increase pressure to de-peg the GCC currencies so as to contain inflationary pressures in the region however it a difficult decision to be made and one which involves other important factors that need consideration.?
Crude oil prices: the crucial factor
While inflation figures in the GCC countries are bound to rise in the aftermath of a depreciation of the US dollar, fiscal spending would remain unaffected if the WTI crude oil prices range between $70-$75 per barrel, “We cannot rule out the possibility of a recession in the US and further economic turmoil in European Union, which will have impact on the crude oil prices. However, we are not anticipating the average prices of benchmark oil to touch levels seen in 2008. We see the average prices of WTI crude oil to remain in the range of $70/bbl to $75/bbl in 2011. The average prices of other benchmark crude oil in 2011 i.e. UK Brent and Opec may drop a further 20-25 per cent below our current expectations in case the US enters recession. While the average prices of WTI, UK Brent and Opec could be lower by 10-15 per cent against our current expected price range for 2012. Despite this, as long as oil prices remain above $70/bbl, GCC countries are likely to remain in comfortable position and would be able to maintain their fiscal spending,? according to Mr. Hasan.
The current debates are reminiscent of the situation in 2007, when GCC countries with the exception of Kuwait decided to retain the peg, and inflation soared to double-digit figures. The Kuwaiti dinar has since been pegged to a basket of currencies, which, to some extent, helped curb inflation back in 2007. However, the situation seems to have changed now,” ?Although the Kuwaiti Dinar is the only currency in the GCC linked to a basket of international currencies it is believed to be heavily weighted towards the dollar, placing it more or less in the same position as the other GCC currencies? GIH said.
Move to a united Gulf currency
Kuwait’s move to end its sole dependence on the US dollar stalled progress towards a united Gulf currency system in 2007, although not much information has lately been released. According to analysts, any lack of recent progress could be attributed to the eurozone financial crisis and the recent political revolutions that have rocked countries in the Middle East. Bahrain, Kuwait, Qatar and Saudi Arabia are the four countries working towards a single monetary system.
Sources: Financial Times, Khaleej Times, Emirates 24|7 Business, Forbes