Tuesday, March 2, 2010 - 08:47
MideastWatch:Dollar-Peg Best Gulf Option 'For Now'-Saudi Bank
By Brai Odion-Esene
WASHINGTON (MNI) - The return to growth of most economies in the Gulf region has increased calls for its central banks to adopt a more independent and flexible monetary policy, but one Saudi bank argues that maintaining the dollar-peg is still the best option for oil-rich Arab countries.
In its 2010 outlook for the nations that make up the Gulf Cooperation Council, the Saudi-American Bank (Samba) says the matter of the exchange rate peg will continue to be an area of debate; particularly as the GCC recovery gathers pace over the next couple of years.
Inflationary pressures are expected to mount while at the same time Gulf governments will be reluctant to use fiscal policy to influence domestic activity given their ambitious investment and diversification programs.
"However, while we recognize the benefits of currency flexibility and an independent monetary policy," Samba said, "we hold the view that the dollar peg currently remains the best option for the GCC.
It argued that the dollar peg helps minimize exchange rate volatility, provides a credible and easily understood anchor for monetary policy, and simplifies trade and financial transactions, accounting and business planning.
"In addition, IMF research has shown that economic activity in the GCC is not particularly sensitive to changes in policy rates," it said, "thus weakening the interest rate transmission channel and the efficiency of an independent monetary policy."
Instead, the report added, corporate sector investment and spending decisions depend to a large extent on actual and projected government spending.
Samba said it does not expect any change in the GCC's exchange rate pegs to the U.S. dollar over the next couple of years -- with Kuwait retaining its peg to a dollar heavy basket of currencies. It pointed out that despite continued progress towards a Monetary Union involving Saudi Arabia, Kuwait, Qatar and Bahrain, announcements from GCC officials concede that this is still a long-term project.
"Given the retention of the dollar peg, GCC monetary policy will continue to be driven by the actions of the U.S. Federal Reserve," it said, "We thus anticipate a continuation of low policy rates in 2010."
As in the U.S., the report expects inflation to be muted in the GCC, and thus do not expect a return of the exchange rate pressures that emerged in 2007-08 when GCC and U.S. policy needs and business cycles were out of synch.
Having fallen steeply from 11.1% in 2009 to 2.5% in 2009, the rate of inflation in the GCC is expected to pick up again this year. However, Samba predicts the increase is likely to be mild, to 3.5%.
"Current forward markets continue to reflect confidence in the dollar peg and are not pricing in any significant revaluation pressure within the next 12 months," it said.
The report does warn of risks, especially if the dollar were to depreciate sharply against other major currencies.
In addition, it advises GCC authorities to monitor local liquidity conditions carefully to prevent a repeat of the unsustainable credit boom experienced by many in 2007-08.
Most regional central banks track loans to deposit ratios and broad money growth, and rely on certificates of deposit, reserve requirements and prudential regulations to manage liquidity, and the report said such activities will need to be strengthened and better coordinated in the region.
It also said banks need to take greater responsibility for their financial risks and strengthen their risk management practises. The report also called for the development of domestic bond markets, saying it would be "a welcome addition," providing a mechanism to manage systemic and private sector liquidity more smoothly in both excess and tight liquidity conditions.
** Market News International Washington Bureau: 202-371-2121 **
MideastWatch:Dollar-Peg Best Gulf Option 'For Now'-Saudi Bank
By Brai Odion-Esene
WASHINGTON (MNI) - The return to growth of most economies in the Gulf region has increased calls for its central banks to adopt a more independent and flexible monetary policy, but one Saudi bank argues that maintaining the dollar-peg is still the best option for oil-rich Arab countries.
In its 2010 outlook for the nations that make up the Gulf Cooperation Council, the Saudi-American Bank (Samba) says the matter of the exchange rate peg will continue to be an area of debate; particularly as the GCC recovery gathers pace over the next couple of years.
Inflationary pressures are expected to mount while at the same time Gulf governments will be reluctant to use fiscal policy to influence domestic activity given their ambitious investment and diversification programs.
"However, while we recognize the benefits of currency flexibility and an independent monetary policy," Samba said, "we hold the view that the dollar peg currently remains the best option for the GCC.
It argued that the dollar peg helps minimize exchange rate volatility, provides a credible and easily understood anchor for monetary policy, and simplifies trade and financial transactions, accounting and business planning.
"In addition, IMF research has shown that economic activity in the GCC is not particularly sensitive to changes in policy rates," it said, "thus weakening the interest rate transmission channel and the efficiency of an independent monetary policy."
Instead, the report added, corporate sector investment and spending decisions depend to a large extent on actual and projected government spending.
Samba said it does not expect any change in the GCC's exchange rate pegs to the U.S. dollar over the next couple of years -- with Kuwait retaining its peg to a dollar heavy basket of currencies. It pointed out that despite continued progress towards a Monetary Union involving Saudi Arabia, Kuwait, Qatar and Bahrain, announcements from GCC officials concede that this is still a long-term project.
"Given the retention of the dollar peg, GCC monetary policy will continue to be driven by the actions of the U.S. Federal Reserve," it said, "We thus anticipate a continuation of low policy rates in 2010."
As in the U.S., the report expects inflation to be muted in the GCC, and thus do not expect a return of the exchange rate pressures that emerged in 2007-08 when GCC and U.S. policy needs and business cycles were out of synch.
Having fallen steeply from 11.1% in 2009 to 2.5% in 2009, the rate of inflation in the GCC is expected to pick up again this year. However, Samba predicts the increase is likely to be mild, to 3.5%.
"Current forward markets continue to reflect confidence in the dollar peg and are not pricing in any significant revaluation pressure within the next 12 months," it said.
The report does warn of risks, especially if the dollar were to depreciate sharply against other major currencies.
In addition, it advises GCC authorities to monitor local liquidity conditions carefully to prevent a repeat of the unsustainable credit boom experienced by many in 2007-08.
Most regional central banks track loans to deposit ratios and broad money growth, and rely on certificates of deposit, reserve requirements and prudential regulations to manage liquidity, and the report said such activities will need to be strengthened and better coordinated in the region.
It also said banks need to take greater responsibility for their financial risks and strengthen their risk management practises. The report also called for the development of domestic bond markets, saying it would be "a welcome addition," providing a mechanism to manage systemic and private sector liquidity more smoothly in both excess and tight liquidity conditions.
** Market News International Washington Bureau: 202-371-2121 **