DUBAI, 17 January 2008 — Gulf Arab oil producers could revalue their currencies together if the US dollar weakens further, with appreciations of 8 percent in the UAE dirham and Saudi riyal likely before April, Standard Chartered said.
Markets piled pressure on Gulf currencies last year as speculation mounted that more Gulf Cooperation Council countries would follow Kuwait and abandon links to the weak dollar partly to curb imported inflation. Kuwait ditched the peg in May.
“It seems likely that GCC countries will maintain their dollar pegs,” Standard Chartered said in a note yesterday. “However, if we see further dollar weakness against the majors a coordinated revaluation by the GCC is possible,” it said.
The bank said it expected GCC revaluation expectations to pick-up ahead of the US Federal Reserve meeting on Jan. 30.
Dollar pegs force the region to shadow US interest rates at a time when the Federal Reserve is cutting rates to contain a credit crisis and inflation is running at decade highs across the Gulf.
The majority of Wall Street firms expect the Federal Reserve to opt for an aggressive 50 basis point interest rate cut at the policy meeting later this month.
Inflation in Saudi Arabia and Oman surged to 16-year highs as central banks across the world’s top oil-exporting region braced for another US interest rate cut that will test their commitment to dollar-pegged currencies.
Inflation in four of the six Gulf Arab oil producers has overtaken official lending rates, encouraging borrowing for investment in assets such as real estate, which is the main driver of the surging cost of living across the region.
Forced to shadow a US Federal Reserve in easing mode to maintain the relative of their currencies, Gulf policymakers are intervening directly in markets, from rent caps in Oman and the United Arab Emirates to higher subsidies in Saudi Arabia.
“Negative interest rates expose the shortcomings of the monetary regime based around the dollar peg,” said Simon Williams, senior regional economist at HSBC. “The economies of the US and the Gulf are so far out of sync that monetary policy in the United States is simply inappropriate for the booming economies of the region,” he said.
Inflation in Oman hit 7.57 percent in November, its highest in at least 16 years. The central bank sets monetary policy at a weekly bill auction and keeps rates below the Fed’s, which have fallen 100 basis points to 4.25 percent since Sept. 18.
Inflation in Saudi Arabia, the largest Arab economy, surged to 6.5 percent in December, the highest since at least 1991, from 6 percent in November. Data for both months were released yesterday.
Inflation in UAE hit a 19-year high of 9.3 percent in 2006, the latest available figure. The benchmark repo rate is at 4.25 percent.
Abu Dhabi and Dubai, the largest UAE emirates, lowered the ceiling on annual rent rises this year. Oman imposed a rent cap last year, and Qatar and Kuwait said they were considering intervening in the property market.
Inflation in Qatar hit 13.73 percent in September just below a record, and the benchmark lending rate is 5.55 percent. Kuwait dropped its dollar peg in May to help curb inflation and kept its benchmark rate steady at 6.25 percent as the Fed cut.
The Saudi central bank has cut the reverse repurchase rate, the benchmark for deposits, to 4 percent in tandem with the Fed.
Like some other Gulf central banks it has been careful to keep the main lending rate, the repo, steady at 5.5 percent to avoid encouraging borrowing. But as with its neighbors, inflation has simply overtaken the “Inflation will stay with us for quite some time in the negative interest rate environment we are entering,” said John Sfakianakis, chief economist at SABB bank in Riyadh. “Negative interest rates have a tendency to fuel real estate price inflation.”
Real estates prices were the main driver of Saudi inflation in November, according to official data. The economy ministry did not release detailed figures for December. Property costs are also fueling inflation in Qatar, the UAE, Oman and Kuwait.
“The only policy option left to them apart from currency reform of some kind is administrative measures aimed at curbing property market speculation,” Standard Chartered said yesterday.
That is exactly what Gulf policymakers are doing.
UAE Central Bank Governor Sultan Nasser Al-Suweidi, who called for currency reform in November, said other government bodies needed to work with the central bank to check prices, according to yesterday’s Financial Times.
Inflation could not be resolved only with monetary and exchange-rate policy, Al-Suweidi, who backtracked on his reform call in December, was quoted as saying.