As a result, we do not anticipate the return of “hot money” speculating on a change in currency policy away from dollar pegs or revaluations. The decision by the Central Bank of Qatar to lower by 50bp the overnight rate in mid-August was prudently intended to curtail additional capital inflows without encouraging a capital exodus at the same time. The overall rhetoric of Gulf policymakers points to unity vis-à-vis currency policy, equity markets have not rallied substantially, real estate prices are still facing downward pressure in most of the Gulf and interest rates remain low.

Yet, bets on an appreciation of the Saudi riyal have widened in the past two months. As at early November, bids on contracts to buy Saudi riyals in two years showed investors are pricing in a 0.6 percent appreciation in the Saudi riyal in two years to 3.7255 per US dollar. One-year forward rates at the beginning of November showed expectations for a 0.4 percent rise in a year. At the height of speculation in the spring of 2008, the expectation was for a 2.2 percent appreciation in the Saudi riyal in a year and a 2.7 percent appreciation in the Saudi riyal versus the US dollar in two years — so speculative pressures are comparatively mild. The current forward levels reflect funding swap positions due to a shortage of US dollar liquidity.

While momentum is building behind the recovery in Gulf economies, economic growth in the Gulf of a projected 3.8 percent in Saudi Arabia, 2 percent in the UAE, and above 3 percent in Kuwait, Oman and Bahrain is being steered by state stimulatory spending. Gulf governments are drawing on foreign assets to finance expansion plans, such as Qatar’s push to build natural gas capacity, the key factor supporting our real GDP growth of 14.8 percent this year. Saudi Arabia overspent budget targets by 25 percent in 2009 and is likely to continue spending with similar force in 2010, likely contributing to its second straight budget deficit.

These investment programs are not in our view propelling inflationary pressures as they were in the pre-crisis years. In the case of Saudi, food price hikes have a pass-through effect of around 75 percent; housing supply shortages are a structural impediment. Oman and Kuwait are also facing some housing supply shortages that should persist over the medium term.

Gulf economies are, hence, in sync with the recovery focus and low-interest-rate environment in the US. Maintaining dollar pegs is therefore not at odds with the region’s economic ambitions and outlook. With regional governments still struggling to re-engage the private sector in the development process and attract foreign investment, weaker Gulf currencies would better enable the countries to promote their non-tradable (tourism) and tradable sectors (manufacturing) and pick up capital injections from European and Asian companies.

The choice of the currency regime must also be understood in the context of the structural importance of the oil sector for GDP, exports and state revenues. Oil and gas production contributes to about half of GDP and three-quarters of exports for Gulf states. The primary challenge for the Gulf is to diversify its economies away from a reliance on oil as much as possible; only the non-oil private sector will be able to create jobs for rapidly growing national workforces. We maintain our view, therefore, that the region is highly unlikely to move away from the dollar peg regime in the medium term.

(Concluded)

— The author is group general manager and chief economist at Banque Saudi Fransi, Riyadh