GCC currency depegging is 'unlikely'
Emirates 24/7 - 10 November, 2010
Gulf oil producers are unlikely end a long-standing peg between their currencies and the US dollar despite its weakening as inflation in the region is still not worrying and the increase in the inflation index has been caused mostly by domestic factors, a prominent analyst said on Wednesday.
John Sfakianakis, chief economist at Banque Saudi Fransi, said the decline in the dollar would adversely affect the economies of the Gulf Cooperation Council (GCC) but ruled out a return to pre-crisis currency speculation by international investors who flooded the region with hot money during 2007-2008.
“The likelihood of the US dollar weakening further in light of the new wave of quantitative easing by the US Fed once again risks exposing the vulnerabilities of Gulf Arab countries whose currencies are pegged to the USD,” He wrote in the latest report of France’s Credit Agricole Bank.
“The extent of the dollar’s depreciation in the months ahead, as well as the extent of complementarities between US and Gulf economic cycles, is likely to renew focus on concerns surrounding imported inflation, the cost of trade and the sustainability of regional currency policies. However, in our view, a shift in currency regime would be highly unlikely.”
Sfakiankis noted that GCC economies are on a recovery footing and inflation rates are not a “concern” in most of the region like they were in 2007-2008.
At that time, vigorous currency reform speculation stemmed from the underlying disparity between the US's struggling economy (forcing Fed rates to fall) and the then-booming economies in the GCC, he added.
“Economic cycles are no longer completely out of sync, with loose monetary policy serving the interests of both, and hence upholding the viability of Gulf dollar pegs….inflation rates in most Gulf states are rising after a period of rapid deceleration, and deflation in the case of Qatar and the UAE, during 2009. It was inflation reaching double-digit levels in 2007 and 2008 that steered currency speculation as the weak dollar drove up imported inflation for import-dependent Gulf economies,” Sfakiankis said in his article, sent to Emirates 24/7.
Citing official data for 2008, he estimated inflation at a record high15.2 per cent in Qatar, 12.5 per cent in Oman, 12.3 per cent in the UAE and 10.6 per cent in Kuwait. Saudi Arabia's inflation rate accelerated at an alarming average pace that year to a decades-high of 9.9 per cent while inflation in Bahrain was more subdued at around 4.7 per cent.
“Any dollar appreciation in 2011 would dissuade anyone from expecting a quick change in policy. The region is known for not changing its mind based on temporary, short-term fluctuations and views,” he said.
“Even with the current phase of dollar weakness, a return to such levels of inflation is unlikely through to the end of 2011. Inflation in Saudi Arabia is now the region's steepest – climbing about six per cent in August – but it is resulting more from domestic supply pressures rather than any acute import inflation pressures and a commensurate depreciation in the real effective exchange rate. In the UAE, for the first nine months of 2010 inflation was 0.6 per cent while Qatar experienced deflation of -3.2 per cent in the first three quarters.”
Turning to economy, Sfakianakis said the GCC economies starkly different to what they were during the cycle of dollar weakness that spurred streams of “hot money” into local currencies and assets in 2007 and 2008.
He said GCC economies are recovering following a challenging 2009, during which aggregate private demand has declined across the region.
Money supply growth is subdued throughout the region and private sector investment is taking a very gradual path towards recovery, he noted.
As for banks, they are holding on to their liquidity due to their reluctance to jump-start lending, while the private sector's appetite for expansion remains anaemic compared with pre-2009 realities, Sfakianakis said.
“Across the Gulf, aggregate demand remains a far cry from pre-crisis levels, the real estate frenzy has subsided, wage inflation is subdued and an abundant labour supply is available. We expect inflation in Saudi Arabia and the UAE – the largest Gulf economies – to be contained,” he said.
“Still, further dollar weakening does not bode well for Gulf economies. Gulf countries are heavily dependent on imports of food, machinery, cars, luxury goods and other items from Asia and Europe. Sharp fluctuations in the dollar could lead to additional variations in the cost of importing various commodities.”
Sfakniankis said he did not expect imported inflation to pass through immediately on the grounds GCC economies denominate more than 60 per cent of their letters of credit in the US currency. Inflationary pressures among key trading partners have also not reached alarming levels.
“While Gulf import bills may swell in the coming months should the dollar weakness be sustained, the cost will be largely offset by greater state revenues stemming from stronger exports to Asia and higher oil prices,” he said.
“Still, higher oil revenues cannot cushion local populations from short-term price shocks, and the previous policy of subsidizing food and increasing wages and salaries has price pressure perils, negative market consequences, harbours inefficiencies and furthers entitlement expectations.”
According the writer, the dollar remains far from the key 1.50 mark vis-a-vs the euro nor it is expected to cross that threshold reached in late 2009 when oil prices were about $ 10 lower than they are now.
“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,” he said.
“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.”
He said that while momentum is building behind the recovery in the GCC economies, growth of a projected 3.8 per cent in Saudi Arabia, around two per cent in the UAE, and above three per cent 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 per cent this year. Saudi Arabia overspent budget targets by 25 per cent in 2009 and is likely to continue spending with similar force in 2010, likely contributing to its second straight budget deficit,” he said.
“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.”
Emirates 24/7 - 10 November, 2010
Gulf oil producers are unlikely end a long-standing peg between their currencies and the US dollar despite its weakening as inflation in the region is still not worrying and the increase in the inflation index has been caused mostly by domestic factors, a prominent analyst said on Wednesday.
John Sfakianakis, chief economist at Banque Saudi Fransi, said the decline in the dollar would adversely affect the economies of the Gulf Cooperation Council (GCC) but ruled out a return to pre-crisis currency speculation by international investors who flooded the region with hot money during 2007-2008.
“The likelihood of the US dollar weakening further in light of the new wave of quantitative easing by the US Fed once again risks exposing the vulnerabilities of Gulf Arab countries whose currencies are pegged to the USD,” He wrote in the latest report of France’s Credit Agricole Bank.
“The extent of the dollar’s depreciation in the months ahead, as well as the extent of complementarities between US and Gulf economic cycles, is likely to renew focus on concerns surrounding imported inflation, the cost of trade and the sustainability of regional currency policies. However, in our view, a shift in currency regime would be highly unlikely.”
Sfakiankis noted that GCC economies are on a recovery footing and inflation rates are not a “concern” in most of the region like they were in 2007-2008.
At that time, vigorous currency reform speculation stemmed from the underlying disparity between the US's struggling economy (forcing Fed rates to fall) and the then-booming economies in the GCC, he added.
“Economic cycles are no longer completely out of sync, with loose monetary policy serving the interests of both, and hence upholding the viability of Gulf dollar pegs….inflation rates in most Gulf states are rising after a period of rapid deceleration, and deflation in the case of Qatar and the UAE, during 2009. It was inflation reaching double-digit levels in 2007 and 2008 that steered currency speculation as the weak dollar drove up imported inflation for import-dependent Gulf economies,” Sfakiankis said in his article, sent to Emirates 24/7.
Citing official data for 2008, he estimated inflation at a record high15.2 per cent in Qatar, 12.5 per cent in Oman, 12.3 per cent in the UAE and 10.6 per cent in Kuwait. Saudi Arabia's inflation rate accelerated at an alarming average pace that year to a decades-high of 9.9 per cent while inflation in Bahrain was more subdued at around 4.7 per cent.
“Any dollar appreciation in 2011 would dissuade anyone from expecting a quick change in policy. The region is known for not changing its mind based on temporary, short-term fluctuations and views,” he said.
“Even with the current phase of dollar weakness, a return to such levels of inflation is unlikely through to the end of 2011. Inflation in Saudi Arabia is now the region's steepest – climbing about six per cent in August – but it is resulting more from domestic supply pressures rather than any acute import inflation pressures and a commensurate depreciation in the real effective exchange rate. In the UAE, for the first nine months of 2010 inflation was 0.6 per cent while Qatar experienced deflation of -3.2 per cent in the first three quarters.”
Turning to economy, Sfakianakis said the GCC economies starkly different to what they were during the cycle of dollar weakness that spurred streams of “hot money” into local currencies and assets in 2007 and 2008.
He said GCC economies are recovering following a challenging 2009, during which aggregate private demand has declined across the region.
Money supply growth is subdued throughout the region and private sector investment is taking a very gradual path towards recovery, he noted.
As for banks, they are holding on to their liquidity due to their reluctance to jump-start lending, while the private sector's appetite for expansion remains anaemic compared with pre-2009 realities, Sfakianakis said.
“Across the Gulf, aggregate demand remains a far cry from pre-crisis levels, the real estate frenzy has subsided, wage inflation is subdued and an abundant labour supply is available. We expect inflation in Saudi Arabia and the UAE – the largest Gulf economies – to be contained,” he said.
“Still, further dollar weakening does not bode well for Gulf economies. Gulf countries are heavily dependent on imports of food, machinery, cars, luxury goods and other items from Asia and Europe. Sharp fluctuations in the dollar could lead to additional variations in the cost of importing various commodities.”
Sfakniankis said he did not expect imported inflation to pass through immediately on the grounds GCC economies denominate more than 60 per cent of their letters of credit in the US currency. Inflationary pressures among key trading partners have also not reached alarming levels.
“While Gulf import bills may swell in the coming months should the dollar weakness be sustained, the cost will be largely offset by greater state revenues stemming from stronger exports to Asia and higher oil prices,” he said.
“Still, higher oil revenues cannot cushion local populations from short-term price shocks, and the previous policy of subsidizing food and increasing wages and salaries has price pressure perils, negative market consequences, harbours inefficiencies and furthers entitlement expectations.”
According the writer, the dollar remains far from the key 1.50 mark vis-a-vs the euro nor it is expected to cross that threshold reached in late 2009 when oil prices were about $ 10 lower than they are now.
“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,” he said.
“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.”
He said that while momentum is building behind the recovery in the GCC economies, growth of a projected 3.8 per cent in Saudi Arabia, around two per cent in the UAE, and above three per cent 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 per cent this year. Saudi Arabia overspent budget targets by 25 per cent in 2009 and is likely to continue spending with similar force in 2010, likely contributing to its second straight budget deficit,” he said.
“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.”