Dollar peg is short-term safety for Gulf

The US dollar peg has shielded GCC economies from the turmoil afflicting global currency markets, however, that link may need to be severed in the future.

All GCC members except Kuwait peg their currencies to the dollar.

The US dollar peg has shielded GCC economies from the turmoil afflicting global currency markets, but central banks still need to be prepared to sever the link in the longer term, economists say.

The peg to the greenback has helped to ensure the GCC is not directly at risk from the kind of rapid currency appreciation other emerging economies have faced, said Guy Monson, the chief investment officer and managing partner of Sarasin & Partners, an investment management company based in London.

"The decision to stay put allows the Gulf to set its own agenda for its currencies rather than be buffeted by the global currency war," he said. "Many other emerging markets … have been looking with envy at the absence of currency pressures that the region has maintained and, with the sharp contraction in credit in Dubai, it has been enormously beneficial." The US, Japan and Europe are among advanced economies trying to devalue their currencies to stimulate stuttering growth and ease deflationary fears.

Developing nations in South America and Asia have blamed such actions on their own currency rises, hampering efforts to control food, wage and asset price inflation as their economies grow more quickly. In a sign of the growing tensions, China yesterday warned US lawmakers that a measure passed by the US House of Representatives aimed at raising the value of the yuan could damage the economy. Guido Mantega, the finance minister of Brazil, has complained his country is facing a "currency war" as foreign capital has surged into local money markets.

Brazil's real has soared about 18 per cent against the dollar this year, with policymakers saying its strong currency is impeding efforts to rebalance its budget deficit and boost exports. All GCC members except Kuwait peg their currencies to the dollar. The peg has helped insulate the GCC from currency fluctuations, although economists say low unemployment and the relatively stable flow of recent hydrocarbon exports have also helped protect states from global currency tensions.

Inflation in the UAE remains relatively benign, rising by 0.54 per cent in the first eight months of the year, official data show. Sultan al Suwaidi, the Governor of the Central Bank, has often repeated the UAE's intention to maintain the current currency regime. Policymakers are anxious to avoid a repeat of 2007, when a flood of speculative money into the region stoked inflation and a housing bubble as investors brought in funds on the expectation that local currencies would be revalued.

The revaluation did not happen and the financial crisis sparked a sudden flight of money, exacerbating a credit crunch. "The dollar makes sense for the Gulf and we haven't seen anything to change that view at the moment," said Tim Fox, the chief economist at Emirates NBD. "The importance of oil means it is to the region's advantage to keep the link for now. Any suggestion about bringing it into question is more of a longer-term issue."

The currency link remained appropriate for the region, said Giyas Gokkent, the chief economist and head of asset management research at National Bank of Abu Dhabi. "GCC economies mainly want a stable US dollar, neither very weak, which causes inflation, nor very strong, which is bad for commodity prices and hence revenues," he said. Saudi Arabia, Kuwait, Qatar and Bahrain are pressing ahead with plans to form a GCC single currency. A peg to the US dollar is considered the most likely initial option for the currency.

Alternatives to the fixed dollar link include a basket of different currencies or a "crawling peg", in which a currency with a fixed exchange rate is allowed to fluctuate within a certain range, said Mr Monson. "I think it's extremely wise to plan for the longer term as the dynamics of the region are different to the US but where the region was wise was not to rush into it," he said.