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Dollar slump heightens inflation woes

Prices rises in the Gulf likely as global currencies battle.

October 17, 2010 4:15 by



A slump in the value of dollar and political backlash over currencies globally may further push prices higher in the Gulf, a region which lacks a flexible monetary tool to control inflation.

Most Gulf currencies are pegged against the greenback, leaving little room for governments to shape independent monetary policies, except for Kuwait, which dropped its dollar peg in 2007 in favour of a basket of currencies.

The dollar has been under pressure recently and prices touched fresh lows for 2010 last week on the view that further balance sheet expansion by the U.S. Federal Reserve would not help the U.S. currency.

Rising inflation has already been a major concern for most major Gulf economies such as Saudi Arabia and Kuwait, especially for food, which is imported and where prices have been climbing.

“The prospect of further dollar weakness is less favourable with imported food inflation becoming a clearer risk,” economists at Emirates NBD wrote in a recent research report.

The trend in food inflation is on the upside in most Gulf economies, Emirates NBD said, with prices increasing 11 percent year-on-year in Kuwait and eight percent in Saudi Arabia.

Saudi Arabia relies heavily on food imports to feed its rising population and is hence vulnerable to rising commodity prices and falling dollar values.

Investors will be looking for an agreement at the G20 meeting in South Korea, a failure of which could hurt financial markets in the short-term by increasing the likelihood of quantitative easing and creating more pressure for currency intervention.

INTERVENTION UNLIKELY

Despite the sharp drop in the dollar’s value, a heated debate about currency pegs and government intervention is unlikely to emerge this time around, most economists say.

Speculation over the viability of dollar pegs is a topic of discussion which emerges frequently in the Gulf Arab region. Back in 2007, when similar speculation swirled, investors heavily bought local Gulf currencies offshore against the dollar to bet on a revaluation.

“Despite accelerating inflation and the recent weakness in the dollar vis-a-vis global currencies, we do not anticipate the debate over whether Gulf states should revalue their currencies will resurface,” said John Sfakianakis, chief economist at Banque Saudi Fransi said in an Oct. 10 report.

The view was also shared by Citigroup analyst Farouk Soussa who said in a recent report that the Kuwaiti government was unlikely to intervene to strengthen the dinar through a revaluation or reweighting of the currency basket.

“The dinar will remain highly correlated to the dollar in the near term despite rising inflation,” the analyst said in the note.

Debates on pegs and a weaker dollar can also be damaging for Gulf states which invest a large chunk of their foreign exchange reserves in U.S. assets.

SOARING DEBT MARKETS

One asset class in the region witnessing ample liquidity and increased investor appetite is the debt market.

Demand for debt issues from sovereign entities and corporates has been increasing at an even faster pace after Dubai successfully raised $1.25 billion from investors last month.

Last week, state-owned Dubai utility DEWA drew hefty demand of $17 billion for $2 billion worth of debt in a two-tranche offer, helped by juicy yields and improved sentiment towards the debt-laden Gulf Arab emirate.

In April, ‘Ba2′-rated DEWA was the first Dubai name to unfreeze the market locked by Dubai’s debt woes, attracting $11.5 billion in bids for a $1 billion bond, despite a high 1.25 percent premium to the underlying sovereign.

Also last week, Qatar Telecom sold $1.25 billion of notes in two parts, its second sale in the month, after the first issue was oversubscribed more than ten times.

Credit default swaps (CDS) on Dubai have been falling sharply recently and are trading at around 375 basis points, significantly lower than the 2010 highs of 655 basis points in mid-February.

On the other hand, quarterly earnings will dominate activity in the equity markets next week and focus will mainly be on bank earnings from the United Arab Emirates.

So far, quarterly reports have been anything but impressive with Saudi lenders disappointing the most as they booked additional provisions during the quarter.

Banks in the UAE are yet to fully provide for their exposure to state-conglomerate Dubai World and investors will be looking for some guidance on the issue this quarter.

(Reporting by Dinesh Nair, Editing by Reed Stevenson)



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