Gulf States Steer Towards Ending Dollar Pegs!

Gulf States have been torched with the rising inflation due to the declining dollar and this has become a huge political issue. After the US currency has fallen more than 13% against the Euro in the last one year, some Gulf States which have pegged their currencies to the US dollar, are considering dropping the pegs, as the inflation reaches new heights.

Marlos Maratheftis, head of research for Standard Chartered in the Middle East said, “Inflation is rising in the Gulf to a great extent because of loose monetary policy. Tightening monetary policy can only happen if they drop their currency pegs or strengthen the currency, preferably both.”

Inflation is high at 12% in the United Arab Emirates and about 18% of this inflation is due to the currency peg to the dollar. This is almost three times more than the government’s target and analysts expect it go up. Inflation in Saudi Arabia has hit 10% and Qatar reported of consumer prices rising almost 14% in the fourth quarter.

Kuwait became the only Gulf State to have dropped the dinar’s peg to the dollar about a year ago, and since then the dinar appreciated 7.9% against the dollar. Several contracts to buy the UAE dirham in about 12 months are trading at 2% premium and for the Saudi Riyal it is 1.2% premium to spot price, which shows that traders are betting that these countries will follow Kuwait in revaluing.

It was in November last year that the revaluation speculation reached a high after the UAE central bank governor said he was considering dropping the dirham’s peg to the dollar.

The reason Gulf countries are thinking on the lines of dropping the pegs has been due to the fact that the dollar has been going down for some time now. If given a chance most Gulf States would depeg the currencies from the dollar, which is falling rapidly. But the problem lies with Saudi Arabia, which has shown resistance in making this move. The U.S. was surely not impressed when Kuwait did this last May, even before the steep descent of the dollar. Gulf government officials reveal their worry about the consequences, as the U.S. may consider any such move as an economic war, since the global economy is fragile.

In such a situation, a currency revaluation against the dollar would be a better option and spells diplomacy. Economists feel that a one-time revaluation of about 20% is required to bring the inflation under control.

There is also speculation that all the GCC states together, excepting Oman, are deciding on forming a single Gulf currency by 2010. The central bank governors are going to meet in June to get the project going.

Simon Williams, chief Middle East economist at HSBC Holdings Plc said, “The case for currency reform is strong. The inflationary pressures the Gulf faces not only demand a stronger currency, they also require an independent monetary policy. The issue is not going to go away, but I don’t believe that change is close.”

There is a lot of discontent with the rising prices. It went to the extent of low-paid migrant workers going on a protest, even risking losing their jobs. This is because these people feel the squeeze of inflation the most.

The Gulf States are forced to slash interest rates at a time when increases are needed. Analysts say that only a change in currency policy can help control the inflation and the political situation.

Analysts believe that revaluation looks to be a plausible response to the crisis at hand. Although this would not make the U.S. any happier, they would certainly consider this a better option since dollar’s status is intact as a reserve currency.

Unless something is done for the dollar to pick up, things are not going to quieten down for a long time to come.

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