GCC Countries Can Draw Lessons From China’s Exchange Rate Experience
Submitted by Editorial Team on September 6, 2010 – 7:19 am0
By Shawkat Hammoudeh
Dr Hammoudeh is Professor of Economics and International Business at Drexel University. He can be reached at hammousm@drexel.edu.
Oil prices have held steady of late, with WTI remaining mainly in the $70-80/B range. There is more room for this price to climb up as the global recovery moves into the expansion stage. It would not be surprising for the WTI price to pass $100/B in 2011. This reminds us of 2008 when the price reached $147/B in July and inflation in some GCC countries touched 14% and real estate bubbles sizzled. The GCC currencies that are pegged to the dollar became undervalued and revaluation became a necessity to combat imported inflation. These countries could not decouple their currencies from the dollar for political and economic reasons.
There is an analogy between the case of the GCC countries in the era of higher oil prices and China during export booms. The rising superpower pegs its currency to the dollar within a very narrow band of ±0.5% of the central parity with the greenback. The export boom has again created inflation and bubbles in China. The Central Bank of China has pursued restrictive monetary policy and interest rates have risen relative to their American counterparts. The renminbi has become undervalued and economists are calling on China to revalue this currency. China wants to “control” the change in its exchange rate, wants to “initiate” the change and wants to make the change “gradual”. The policy prescription for these three conditions is that China should replace the effectively single exchange rate regime by an exchange rate band. The range of the band can satisfy the three conditions.
As we can draw a parallel between Dubai and Greece’s debt woes, we can do the same between the GCC currencies/dollar peg and the renminbi/dollar exchange rate regime, as follows:
*
The GCC can move from a single peg to a currency band. At the start, the range of the band can be very small – as small as ±05% as is the case with China. They can test the responses of their currencies to the forces of supply and demand in the foreign exchange market.
*
The movement of the exchange rates within the narrow band can give the GCC countries a sense of the true values of their currencies. If the dollar/GCC currency sticks to the upper bound most of the time, then this is a clear indication that the GCC currency is undervalued.
*
The GCC country should then widen its bands if the exchange rate continues to touch the upper limit. The change in the band should be done very discretely and with enough depth to prevent future speculations.
*
The change of the band should be large enough, but sporadic, also to prevent speculations.
*
The currency band can be narrowed when the GCC governments decide to move to the GCC Union to facilitate the transition to a common currency. Then the ‘GCC dinar’ can again move within a wider band against the dollar.
*
The GCC countries should take account of their changing trading markets when they set exchange rates. Now it is China and not the US that is the largest recipient of Saudi oil exports. It will not be long before the Chinese market will become the largest market for Saudi imports as well. China (and other large East Asian countries) will figure high in the GCC countries’ trade balances. While oil is priced in dollars, the Chinese exports are not. The GCC countries should be cognizant of the changes in the economies, financial systems and exchange rates of their largest trading partners. If China adopts a currency band and anchors the renminbi around the dollar, Saudi Arabia should do likewise. When the renminbi soars to the upper limit of the band during an export boom, the pegged riyal and other GCC currencies will want to appreciate during a corresponding oil boom. If the GCC follows a currency band, their currencies will then appreciate freely with the renminbi and the currency congruence will make changes in exchange rates neutral to bilateral trade balances and imported inflation.
*
On political grounds, the US is not as influential in the GCC countries as it was before, despite its strong military presence in the Gulf. The Saudis are less concerned about US reaction than before when, for example, they decide on oil prices. China is now their largest export partner and not the US. So America will have less reaction to a GCC self-engineered exchange rate policy than before. The reaction will get weaker as long as oil is priced in dollars and the dollar is the international reserve currency.
*
Looking at the alternative to the dollar, the recent turmoil in the Eurozone has cast doubts on the euro as a reliable reserve currency and currency anchor. This has given the dollar greater credibility than before. A currency band around the dollar is the viable alternative to a single dollar or euro peg.
These ideas will become more relevant as we move into 2011. I suggest that the reader visits them from time to time as we come closer to 2011 and beyond. The GCC can draw more lessons from other countries’ experiences, not only in terms of Greece’s debt but also in terms of China’s exchange rate.
Submitted by Editorial Team on September 6, 2010 – 7:19 am0
By Shawkat Hammoudeh
Dr Hammoudeh is Professor of Economics and International Business at Drexel University. He can be reached at hammousm@drexel.edu.
Oil prices have held steady of late, with WTI remaining mainly in the $70-80/B range. There is more room for this price to climb up as the global recovery moves into the expansion stage. It would not be surprising for the WTI price to pass $100/B in 2011. This reminds us of 2008 when the price reached $147/B in July and inflation in some GCC countries touched 14% and real estate bubbles sizzled. The GCC currencies that are pegged to the dollar became undervalued and revaluation became a necessity to combat imported inflation. These countries could not decouple their currencies from the dollar for political and economic reasons.
There is an analogy between the case of the GCC countries in the era of higher oil prices and China during export booms. The rising superpower pegs its currency to the dollar within a very narrow band of ±0.5% of the central parity with the greenback. The export boom has again created inflation and bubbles in China. The Central Bank of China has pursued restrictive monetary policy and interest rates have risen relative to their American counterparts. The renminbi has become undervalued and economists are calling on China to revalue this currency. China wants to “control” the change in its exchange rate, wants to “initiate” the change and wants to make the change “gradual”. The policy prescription for these three conditions is that China should replace the effectively single exchange rate regime by an exchange rate band. The range of the band can satisfy the three conditions.
As we can draw a parallel between Dubai and Greece’s debt woes, we can do the same between the GCC currencies/dollar peg and the renminbi/dollar exchange rate regime, as follows:
*
The GCC can move from a single peg to a currency band. At the start, the range of the band can be very small – as small as ±05% as is the case with China. They can test the responses of their currencies to the forces of supply and demand in the foreign exchange market.
*
The movement of the exchange rates within the narrow band can give the GCC countries a sense of the true values of their currencies. If the dollar/GCC currency sticks to the upper bound most of the time, then this is a clear indication that the GCC currency is undervalued.
*
The GCC country should then widen its bands if the exchange rate continues to touch the upper limit. The change in the band should be done very discretely and with enough depth to prevent future speculations.
*
The change of the band should be large enough, but sporadic, also to prevent speculations.
*
The currency band can be narrowed when the GCC governments decide to move to the GCC Union to facilitate the transition to a common currency. Then the ‘GCC dinar’ can again move within a wider band against the dollar.
*
The GCC countries should take account of their changing trading markets when they set exchange rates. Now it is China and not the US that is the largest recipient of Saudi oil exports. It will not be long before the Chinese market will become the largest market for Saudi imports as well. China (and other large East Asian countries) will figure high in the GCC countries’ trade balances. While oil is priced in dollars, the Chinese exports are not. The GCC countries should be cognizant of the changes in the economies, financial systems and exchange rates of their largest trading partners. If China adopts a currency band and anchors the renminbi around the dollar, Saudi Arabia should do likewise. When the renminbi soars to the upper limit of the band during an export boom, the pegged riyal and other GCC currencies will want to appreciate during a corresponding oil boom. If the GCC follows a currency band, their currencies will then appreciate freely with the renminbi and the currency congruence will make changes in exchange rates neutral to bilateral trade balances and imported inflation.
*
On political grounds, the US is not as influential in the GCC countries as it was before, despite its strong military presence in the Gulf. The Saudis are less concerned about US reaction than before when, for example, they decide on oil prices. China is now their largest export partner and not the US. So America will have less reaction to a GCC self-engineered exchange rate policy than before. The reaction will get weaker as long as oil is priced in dollars and the dollar is the international reserve currency.
*
Looking at the alternative to the dollar, the recent turmoil in the Eurozone has cast doubts on the euro as a reliable reserve currency and currency anchor. This has given the dollar greater credibility than before. A currency band around the dollar is the viable alternative to a single dollar or euro peg.
These ideas will become more relevant as we move into 2011. I suggest that the reader visits them from time to time as we come closer to 2011 and beyond. The GCC can draw more lessons from other countries’ experiences, not only in terms of Greece’s debt but also in terms of China’s exchange rate.