Heads of state of the members of the Gulf Cooperation Council were set to discuss whether or not to alter their existing dollar peg when they met in Doha, Qatar, on December 3. According to a report entitled Gulf currencies: change needed and likely, written before the meeting by Gerard Lyons and Marios Maratheftis at Standard Chartered: "A revaluation of the GCC currencies is needed now and the region should begin preparations to shift their currencies away from a peg to the dollar to managing their currencies against a basket of currencies with which the Gulf trades."
The authors add: "This shift in currency policy is needed not only to reflect the present vulnerable state of the dollar, but more importantly to help position the region’s economy for both the cyclical and structural shifts that it is undergoing." The GCC members – Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates – plan to move to a single currency by 2010. However, economic tensions make it unlikely that they can achieve the necessary level of convergence to see the plan through on time.
In the past, the GCC’s dollar peg has brought benefits. "The decision to peg their currencies to the dollar achieved credibility by tying the region’s monetary policy to that of the US Fed, and also achieved certainty in the minds of the general public. There is, however, a cyclical challenge," Lyons and Maratheftis write. "As the UK found to its cost when it was tied to Germany and the Deutsche Mark in Europe’s Exchange Rate Mechanism in the early 1990s, once there is a disconnect between the policies needed at the centre of the system and those needed elsewhere then problems develop. A similar episode, albeit different in scale, is now being seen in the Gulf. Whilst the US is cutting interest rates in response to a slowing economy, the Gulf needs a tighter monetary policy to curb inflation."
Breaking ranks
Kuwait has already broken ranks, having moved to a basket of currencies in May. According to Caroline Grady, an economist at Deutsche Bank, this had been predicted, even though Kuwait had denied it would make such a move unilaterally. At the time, the decision was seen as a negative for the move to a single currency but it has given Kuwait a greater degree of control over its economy. "Trying to follow US monetary policy is no longer efficient for the GCC," says Grady. "Saudi Arabia did not follow the last US rate cut and the UAE, which effectively has negative interest rates of around 4%, may decide to follow Kuwait’s move because of inflationary pressures."
Grady says that there is a strong argument that all the GCC members’ currencies are too weak and need to be revalued. "There is an economic call for stronger currencies across the region. However, there’s been so much attention focused on the issue that the GCC may well decide to leave any revaluation until people are not looking so closely," she says.
Lyons and Maratheftis state that there is a high probability that nothing will be decided at the meeting. Sticking to the current peg, they say, will provide a stability anchor for policy, but it will leave the economy at "the mercy of US interest rates". They also feel that there is a chance for a revaluation and even a move towards an undisclosed basket of currencies.
"The peg to the dollar has worked well but now is the time for change. But change is never easy," their report says. "There can be losers as well as winners, particularly if one outcome is an appreciation versus the dollar that may reduce the region’s return, as well as the total value of its overseas assets. Yet, despite this, the region’s policymakers need to seize the opportunity afforded to them and think global."