| Kippreport.com

Gulf currency pegs seen surviving weak dollar for now

November 23, 2010 12:11 by Reuters

The Fed’s moves to pump money into the U.S. economy may revive questions about the dollar pegs used for Gulf Arab currencies, but policy change in the conservative oil producing region seems to be a long way off.

Policymakers in the world’s top crude exporting region have long said that dollar pegs serve their hydrocarbon-heavy economies well as long as inflation stays under control.

As key Gulf economies continue to recover, inflation has started to pick up. In Saudi Arabia, Kuwait and the United Arab Emirates it has already hit 18-month highs, though it is still far below 2008 record peaks.

No wonder then that the weak dollar, which touched an 11-month low against a basket of currencies early this month in response to U.S. Federal Reserve policy, has obliged Gulf officials to deny any risks to pegs in the region, which relies heavily on imports.

Even so, forwards now price in just 0.3 percent firming in a year for Saudi Arabia’s currency compared with 2.7 percent at the height of 2007 speculation that imported inflation would force the region to ditch its dollar pegs.

“The Gulf states should keep their dollar fixes for the foreseeable future,” Robert Mundell, the Nobel Prize-winning economist from Columbia University in New York, told Reuters. “The only good argument for changing the fix would be if the dollar became unstable or it declined as the premiere anchor currency,” said Mundell, who has recently become an adviser to the United Arab Emirates central bank.

Some economists have warned that the Fed’s latest bid to kick start the U.S. economy with a $600 billion injection could fuel inflation and put the credibility of the dollar at risk.

But as long as dollar weakness is offset by the shaky euro and dollar-denominated oil remains the key revenue earner for Gulf governments, greenback pegs — politically sensitive for strong U.S. allies — look safe.

INFLOWS SMALL

Apart from the inflation risks, speculation on pegs and a weaker dollar can be damaging for Gulf states which invest a large chunk of their foreign exchange reserves in U.S. assets.

Back in 2007, when speculation on revaluation swirled, hot money poured into Gulf Arab countries, making Kuwait break ranks with fellow Gulf states and drop its peg in favour of a currency basket to fight inflation.

This summer, Qatar’s central bank slashed interest rates to keep speculative capital out of an economy growing at double digit rates, unlike the rest of the Gulf.

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