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Gulf to keep currency peg to dollar: Study
Published in The Saudi Gazette on 11 - 11 - 2010

JEDDAH: Gulf currencies that are still pegged to the US dollar “are unlikely the currency regime”, Credit Agricole Corporate and Investment Bank said in it latest study.
“Firstly, the forces at play today - both domestic and external - are quite different from 2007-08, as Gulf economies are on a recovery path, as is the US economy, hence no harm in following the US policy (rates and FX),” John Sfakianakis, chief economist BSF-Crédit Agricole Group, said in the report.
Gulf central banks are preoccupied with credit recovery and non-oil private sector growth, he added.
“Secondly, inflation is not a source of concern even if price pressures have been building in some countries, notably Saudi Arabia,” he further said, adding that double-digit inflation in all Gulf economies is not forecast through to 2011.
The likelihood of the US currency weakening further in light of the new wave of quantitative easing (QE2) by the US Federal reserve once again risks exposing the vulnerabilities of Gulf Arab countries whose currencies are pegged to the US dollar, the study said.
Moreover, the extent of the dollar's depreciation in the months ahead, as well as the extent of complementarities between US and Gulf economic cycles, is likely to renew focus on concerns surrounding imported inflation, the cost of trade and the sustainability of regional currency policies.
Data from Saudi Arabian Monetary Agency (SAMA) showed Wednesday that Saudi money supply growth rose to 5.1 percent on the year in September from 2.9 percent in August, and the central bank's foreign assets increased 9.7 percent on the year.
M3, the broadest measure of money supply, came in at SR1.051 trillion ($280.2 billion) in September, up from SR999.9 billion in the same month a year ago, and SR1.023 trillion in August, according to data posted on SAMA's website.
SAMA's net foreign assets edged up to SR1.582 trillion in September from SR1.574 trillion in August and SR1.427 trillion in September 2009, the data showed.
BSF-Crédit Agricole Group report further said
that Gulf inflation, though beginning to climb, is yet benign and “still not ringing alarm bells.”
Gulf economies are on a recovery footing and inflation rates are not a concern in most of the region like they were in 2007-08. At that time, vigorous currency reform speculation stemmed from the underlying disparity between the US's struggling economy and the then-booming economies in the Gulf.
“Economic cycles are no longer completely out of sync, with loose monetary policy serving the interests of both, and hence upholding the viability of Gulf dollar pegs,” the report added.
Even with the current phase of USD weakness, a return to such levels of inflation is unlikely through to the end of 2011. Inflation in Saudi Arabia is now the region's steepest - climbing about 6 percent in August - but it is resulting more from domestic supply pressures rather than any acute import inflation pressures and a commensurate depreciation in the real effective exchange rate. In the UAE, for the first nine months of 2010 inflation was 0.6 percent while Qatar experienced deflation of -3.2 percent in the first three quarters.
Saudi inflation is neither comforting nor alarming at the moment, reaching a historically high 5.2 percent in the first nine months of 2010 due to a mix of high food prices, continued steep rents and a general rise in the cost of goods and services. Even in Saudi Arabia, though, inflation is nearly half its 2008 peak - and price rises are not fixable with monetary policy at the moment, the bank said in the study.
Moreover, as the revaluation debate is not making a comeback, an inflow of capital in the form of bank deposits is not expected to recur.
Across the Gulf, aggregate demand remains a far cry from pre-crisis levels, the real estate frenzy has subsided, wage inflation is subdued and an abundant labor supply is available.
“We expect inflation in Saudi Arabia and the UAE - the largest Gulf economies - to be contained,” Sfakianakis noted.
Saudi inflation is likely to average 5.3 percent this year and 4.7 percent in 2011, while UAE inflation should not exceed 1 percent in 2010 and 3.1 percent next year.
Still, further US dollar weakening does not bode well for Gulf economies.
Gulf states are heavily dependent on imports of food, machinery, cars, luxury goods and other items from Asia and Europe. Sharp fluctuations in the US dollar could lead to additional variations in the cost of importing various commodities.
However, the study ruled out imported inflation to pass through immediately, since Gulf economies denominate more than 60 percent of their letters of credit in the US currency. Inflationary pressures among key trading partners - more than 50 percent of Gulf imports are sourced from China, Japan, the eurozone and the US - have also not reached alarming levels, it said.


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