Increased Middle East social spending may aid dollar

LONDON: Increased public spending to shore up social stability in parts of the Middle East is likely to make regional central banks less keen to diversify their foreign exchange reserves — to the benefit of the dollar.
In order to spread the risk of excessive holdings of one currency, central banks in the Arab world and elsewhere have been keen to shift a portion of their holdings into other currencies, especially the euro.
However, greater Middle East public expenditure may mean the pace of foreign reserves growth slows. Since many countries in the region are paid in dollars for oil and gas exports, this should mean less reserve diversification-linked selling of the US currency.
Arab economies around the Gulf have spent heavily to shore up social stability through welfare schemes and infrastructure projects.
Saudi Arabia last year committed to spend $67 billion over several years to build 500,000 new homes.
Even with the price of Brent crude still above $110 a barrel, a preliminary report released recently by the International Monetary Fund raised concerns about the sustainability of Kuwait’s public finances in the medium term given the increased outlays.
Greater diversion of revenues to fund local projects in the Middle East could slow the pace of reserve accrual, thereby lessening the absolute size of diversification flows.
This, along with the euro zone’s own troubles, should see fewer dollar reserves being exchanged for the common European currency by Middle East reserve managers.
Retention of dollars, given the depth of liquidity in and the ease of access to US asset markets, makes good sense, said one central banker in the region.
At the same time, with local currencies such as the Saudi riyal, pegged to the dollar, and the Kuwaiti dinar, pegged to an undisclosed basket of currencies that is believed to be heavily dominated by the greenback, holding the US currency arguably makes more sense as new local expenditure projects are implemented.
To help fund this extra public spending, Middle East producers will undoubtedly hope to keep the oil price relatively high.
All hydrocarbon importing countries will have to pay the price but the US is more cushioned than many. Bountiful US shale gas and shale oil will provide the United States with a buffer against a crude price hike.
This is already evident in the disparity between the price of Middle East-originated Asian liquefied natural gas (LNG) prices and North American natural gas futures.
A near $18 per million British thermal units (mmBTU) price for Asian LNG gives a big competitive advantage to US manufacturers paying some $2.50/mmBTU for natural gas generated in North America.
The US economy may benefit further if Washington decides to approve natural gas exports.
From a number of angles, the dollar seems well positioned to benefit from the consequences of the Arab Spring.
— Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own