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A marriage of convenience

A marriage of convenience

As rising inflation rates continue to haunt GCC economies, a look at why the region’s currency is clinging to the failing dollar.

September 7, 2008 8:32 by

Dana El-Baltaji

Inflation hasn’t been kind to the GCC. The continued rise in official inflation rates, which range between 9 percent and 13.6 percent throughout the region, has forced the labor force to contend with rising costs of food and rent. And while the official percentages are bad enough, the reality on the ground is worse. Speculators believe that rents in Qatar and the UAE have doubled since 2006, and the price of food is rapidly rising.

But far from the riots in Indonesia and India, where inflation caused by the failing dollar and the rising price of oil has sent angry workers to the streets, the GCC is in a state of calm. It’s true that the GCC currencies have suffered because of the depreciating dollar, and that rising inflation has led many businessmen to blame the greenback for their woes, but the governments in the region have yet to budge on their commitments to the dollar, with Saudi Arabia and the UAE dismissing rumors of an imminent depegging.

And that is good news for the US. It means that two of the region’s strongest economies are unwilling to severe their economic ties with the dollar just yet. It also means that they do not intend to toy with the $2 trillion worth of US-denominated assets. Not yet anyway.

Yet, in spite of these assertions, GCC businessmen continue to call for their governments to severe their ties with the dollar, and to allow local currencies to soar along with the local economies. Not only are companies losing essential profits due to the rise in construction, food and oil costs, but employees across the region who habitually repatriate a portion of their salaries are watching the value of their remittances plummet. Riots erupted late last year in Dubai when hundreds of construction workers protested against the failing dollar, stating that they are unable to send sufficient sums to their families in the subcontinent.

In spite of the growing pressure to appease the workforce, GCC governments (save for the Kuwaiti government, which depegged in May 2007) are unlikely to depeg their currencies from the dollar anytime soon. Ultimately, the issue of the peg is both a political and economic one.

Economic ties. Deciding to depeg may require the GCC to jeopardize an economic marriage founded on oil, securities and military support. Each needs the other to survive. Without the support of petrodollars from the GCC, many of which are used to buy US-denominated securities, the dollar will depreciate quickly and the world economy would suffer. And without US military support against the potential threats of the GCC’s neighbors, such as Iran and Iraq, and the monetary policies of the US-established currency and markets, the GCC would not be enjoying its extraordinary boom.
In short, pegging their currencies to the dollar has given GCC economies an opportunity to mature. However, the declining dollar prompted Kuwait, one of the most established markets in the GCC, to depeg its currency in May 2007. While it may appear Kuwait has bitten the hand that feeds it, the undisclosed currency basket the dinar is pegged to is rumored to have a 70 percent to 80 percent dollar component.

And according to Eckart Woertz, program manager of economics at the Gulf Research Center, “the most important thing is not the peg but the investment of petrodollars in dollar-denominated securities.”

This is where the sudden love towards sovereign wealth funds (SWF) comes in. A year ago, US senators were claiming that investments made by Arab SWFs were a threat to national security; today the tone has changed. In his article entitled “US and Gulf interdependence,” Woertz claims the Abu Dhabi Investment Authority’s $7.5bn investment in Citigroup was hailed by New York senator Chuck Schumer; ironically, the same senator “was one of the leading campaigners against the takeover of P&O’s US facilities by Dubai Ports World. [Today] he risks reproaches of being soft on security.”
Opening their doors to Arab SWFs (whether publicly or privately), further complicates the depegging issue. More investments in the US means the GCC stands to lose more dollars if the nations decide to depeg.

Monetary union. In addition to keeping their relationship with the US intact and maintaining the values of their foreign assets, regional governments have yet another clincher that ties them to the dollar: their dream of a single GCC currency. As per the GCC’s timetable, local currencies must maintain their peg to the dollar in order to establish stabilized exchange rates throughout the region. Kuwait’s decision to depeg, therefore, has thrown the timetable into disarray. Now the implementation of a single currency is likely to be pushed back two years to 2012.
In spite of this setback, a single currency continues to entice governments in the region. Given the need to diversify their economies, GCC nations are keen to create environments ideal for trade and development. This involves a dismantling of trade barriers and a monetary union that is pegged to the dollar either directly or as part of a basket currency.

Although GCC currencies (except the Kuwaiti dinar) have stuck with the dollar over during the greenback’s dark days, some analysts feel that the marriage of convenience established between the US and the region may soon end if the dollar doesn’t shape up soon.

Iskandar Najjar, director of Advanced Currency Markets (ACM) for the Middle East and Asia feels the situation is coming to a head. “Until about a month ago, the dollar was depreciating aggressively,” he says. “Over the past year it has dropped between 30 and 40 percent. What’s happening today is a major correction on the dollar. They’re past the worst of the credit crunch, their economic data is improving and the dollar is starting to appreciate. So, the pressure on the GCC governments to revalue or depeg from the dollar has been lifted for the time being. But the long-term outlook to the dollar over the next year is that there is going to be continued depreciation. So deciding to not depeg today is only a short term solution.”

What’s the long-term solution? According to Najjar’s colleague, Hussam Saba, a market analyst at the same firm, “The best option right now is to wait. But any more depreciation of the dollar should get the GCC to start thinking about depegging seriously.”

Hot air. The GCC, however, has been toying with the idea of depegging for at least a year now. If the depreciation of the dollar hasn’t already prompted governments to depeg from the dollar, “Why should they do it now?” asks Woertz. And while some believe that inflation may be solved by breaking away from the dollar, he insists that while that “will have some effect, depegging is not a panacea. It won’t solve the problem.”

So what will solve the problem? “Nothing right now,” is Woertz’s sobering response. “Inflation, so to speak, is the solution because there is so much money chasing few goods, which results in inflation. Theoretically, you should raise interest rates, but no one is doing that now in this kind of threatening scenario. And the GCC countries can’t do it anyway because they are pegged to the dollar.”

Which begs the question: Can the GCC’s currencies ever depeg from the dollar? According toWoertz, technically, yes, but practically no. “Anyway,” he explains, “[GCC currencies] cannot go anywhere else anyway because other capital markets are not that developed and they cannot be developed so long as the whole wide world is basically fuelled by the US deficit spending. They pay us in paper and we pretend it’s worth something, and as long as that goes on, then the world economy keeps running. Otherwise there’s a problem.”

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1 Comment

  1. John Lavery on October 2, 2008 10:43 pm

    Tell me more? I can’t open the link, but will listen.
    JTLavery at aol dot com.


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