Weak dollar a risk for Gulf economies: Krugman

The dollar will fall in value this year, devaluing the dirham and other Gulf currencies pegged to the greenback, according to Paul Krugman, a Nobel prize-winning economist. International investors who fled to dollar-denominated assets as a safe haven will begin re-investing their funds in other currencies, he said. This shift, although unlikely to hurt the US economy, could bring risks for Gulf economies that peg their currencies to the dollar. "The credit markets are finally stabilising. There was clearly a rush into US treasury bills in a dangerous world. But take that away, and people aren't going to be quite so willing to hold dollars," Mr Krugman said in an interview in Abu Dhabi yesterday. "If you are some third party that is pegged to the dollar, you're getting a devaluation. Was that what you had in mind? Was that a policy?" The dollar fell the most against the euro in two months last Friday as the currency finished the week down against all of the 16 most actively traded currencies tracked by Bloomberg. Mr Krugman, who gained recognition for predicting problems caused by fixed exchange rates in South East Asia during the 1997 financial crisis, said the UAE and its GCC neighbours should instead consider linking their currencies to a basket which gives more or equal weight to the euro than to the dollar. "This region is closer to Europe than it is to the US, so why should the dollar be the sole peg?" De-pegging could give countries more flexibility to tailor their monetary policy to their specific economic needs according to Mr Krugman, who cited the example of Argentina in the 1990s. "I am very influenced by examples. Argentina, with its convertibility law and the peg to the dollar, got whipsawed by a rising dollar in the late 90s which priced Argentine goods out of competition with Brazilian goods, which was crazy," he said. The UAE has maintained a fixed exchange rate with the US currency since 1997, although its currency has tracked the dollar since 1978. As recently as last year, a rapid appreciation of the dollar stoked inflation throughout the Gulf, bringing it to dangerously high levels, many economists warned. Although the global economic slowdown has slowed the rate of inflation in the UAE, some economists have still called for the Central Bank to cut the dirham free of the dollar in order to follow a more independent monetary policy. Among GCC states, only Kuwait has dropped the dollar peg. It moved to a basket of currencies in 2007. Although the exact composition of Kuwait's currency basket is not known, analysts say it consists mostly of dollars. Mr Krugman said the UAE's decision to unilaterally withdraw from a planned GCC monetary union last week may not be a significant loss even if it threatens to derail the common currency project. "I wouldn't shed a whole lot of tears over failure to create a currency union in this area," he said. "I tend to be sceptical about monetary union projects. ? Labour mobility helps, and again [in the GCC] you have very high labour mobility, but even the euro zone is having exactly the problems that a currency union sceptic would expect: one size fits all monetary policy, lack of fiscal integration, and so on." The decision to withdraw from the monetary union project was caused mainly by the GCC's decision to locate the planned Gulf central bank in Riyadh, rather than Abu Dhabi, government officials have said. Mr Krugman is speaking today on the outlook for the global economy at the Megatrends conference in Abu Dhabi. [e-mail]