Gulf currency pegs 'pegging their currencies to the dollar, the Gulf Co-operation Council states (Saudi Arabia, Kuwait, Bahrain, Qatar, United Arab Emirates and Oman) surrendered the tool of interest rates to control inflation."
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Gulf currency pegs
Published: November 16 2007 09:29 | Last updated: November 16 2007 19:55
The speculation swirling around Middle Eastern currencies is a rare instance of economic textbooks being followed to the letter. So widespread is the belief that half a dozen Gulf states have little choice but to revalue their currencies that investors from hedge funds to retail brokers are all placing their bets.
By pegging their currencies to the dollar, the Gulf Co-operation Council states (Saudi Arabia, Kuwait, Bahrain, Qatar, United Arab Emirates and Oman) surrendered the tool of interest rates to control inflation. Monetary policy, instead, has to mirror the country to which the currency is pegged – in this case the US. Enforced monetary discipline and a stable currency often serve developing economies well. For GCC states, where the main export, oil, is dollar-denominated, it made particular sense.
But the pegs are under strain. A falling dollar, record oil prices and higher food and housing costs are causing inflation to tick up. A slowing US economy has resulted in a 75-basis-point reduction in US rates since the summer, just when the GCC needs tighter, not looser, monetary policy. In addition, underdeveloped local bond markets have made it hard for central banks to soak up liquidity by borrowing locals’ excess cash. This helps explain why money supply growth and equity markets are surging.
This week, the governor of the UAE’s central bank twice questioned the existing currency regime. Such talk is counterproductive, as anything but silence can lead to self-fulfilling speculation. Even so, a blanket punt that the remaining GCC states will follow Kuwait’s move to a more flexible peg is no sure thing. The US will resist another blow to sentiment against the dollar. It is also arguable that the region’s export base is not yet diversified enough. Finally, a drop in oil prices might cool inflation long enough for a currency union to move back up the agenda, the GCC’s ultimate goal. |
