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Under the spell of the tumbling dollar

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November 19, 2007 10:00 by



dollar, GCC

Procrastination, as they say, is the thief of time. Perhaps officials and economists in the Gulf believe time is on their side, to judge from the endless stalling on whether the regional currencies will stay pegged to the US dollar. The impact of the falling dollar – which has slumped 29 percent against the euro and 26 percent against the pound – has already been felt and a further decline will result in more exchange rate losses and likely further push up inflation. Right now the dollar peg stays, and officials won’t be drawn on why. The explanation from some quarters, that “we went into it together and we will go out of it together,” sounds like make-believe, given Kuwait’s decision earlier this year to unshackle the dinar from the dollar.

Since May the dinar, now tied to a basket of currencies, has risen 4.06 percent. The Kuwaiti central bank says the dollar’s decline continues to hurt, however, making some imports more expensive. Nevertheless, the basket of currencies option has, according to the central bank, given it the flexibility to track moves in global foreign exchange markets. Intriguingly, though, the weighting of the currencies in the basket has not been disclosed. Analysts suggest the dollar still accounts for the lion’s share, perhaps as much as 70 percent.

A foreign currency peg means that a country loses control of some aspects of its economic policy, notably interest rates. In theory, participating countries set their monetary policy in order to maintain the value of the peg. Hence the UAE central bank, for example, raises or cuts interest rates only when the US Federal Reserve does. This means a central bank can’t act unilaterally to, for example, raise interest rates to curb inflation, for fear of upsetting the peg, a tricky situation to be in.

Kuwait’s decision raised expectations of more currencies following suit, but that did not happen. Yousef Hussain Kamal, the finance minister of Qatar, recently said that changing the peg would be “destabilizing” for Qatar. “Why should I change the peg, when 100 percent of my exports and products are in the US dollar? My products look cheaper compared to the non-dollar pegged products. Otherwise, I cannot sell them,” he told Qatar Banking Review 2007 – a report prepared by the Qatari banks as part of the Doha round of World Bank/IMF annual meetings. Kamal said Qatar and other energy-rich countries would not have been able to sell oil at the current very high price if the dollar was as strong as it was some five years ago.

A study conducted by the Federal Reserve Bank of New York found that the GCC countries invest almost a quarter of their oil revenues in dollar-denominated assets. Potentially, the euro would be the biggest beneficiary should Gulf countries shift reserves, because the euro zone is one of the Arab region’s biggest trading partners. Analysts also hint at a possibility of the dollar coming under further pressure if GCC countries decide to revalue their currencies and remove the peg to the greenback, prompting a flight out of US assets by Middle East countries. All this is happening at a time when the dollar index – a measure of the currency’s value against six major currencies – recently fell to 77.363, its lowest level since its inception more than 30 years ago.

The weak dollar has led to imports, most of which are denominated in euros, costing more in GCC countries. Chances are that if the dollar drops further and Gulf currencies fall with it, the region will now import inflation from its trade partners in Europe. That is precisely why analysts believe flexible exchange rates are the best way forward: currently, the GCC currencies are undervalued by at least 25 percent. The large expatriate workforce in the Gulf is said to be losing between 20 percent and 30 percent of earnings to inflation and the exchange rate disequilibrium. Simply put, further value erosion means the currency buying less and less of what it did in the past. But despite all this, the dollar peg will likely prevail.

First seen at www.trendsmagazine.net



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