Gulf states ‘to drop’ dollar peg on Fed Reserve action

Published: Wednesday, 6 February, 2008, 02:16 AM Doha Time
DUBAI: Gulf states including Saudi Arabia and the United Arab Emirates will be forced to revalue their currency pegs this year following the dollar's declines and the Federal Reserve's interest-rate cuts, Bear Stearns has said.

Five Gulf nations lowered interest rates last week in step with the US to keep their links to the dollar even as inflation accelerates. When Saudi Arabia left rates unchanged after the Fed's Sept. 18 reduction, the riyal rose to a 20-year high.

It's going to be very difficult for central banks in the region to have adequate control of monetary policy, and hence inflation, when the Fed is slashing rates left, right and centre and the dollar is slumping, Steven Barrow, chief currency strategist in London at Bears Stearns, wrote in a client note yesterday.
Inflation accelerated to records in all GCC, states last year as the oil-rich nations sought to preserve their dollar links. The regional average was 6.3% in 2007, compared with 0.3% in 2001, according to Merrill Lynch & Co

The Fed cut its target rate for overnight bank lending by 1.25 percentage points in January to prevent the housing slump from pushing the world's biggest economy into a recession.

The US Dollar Index traded on ICE Futures in New York, which tracks the currency against six major counterparts, dropped 0.7% last week to 75.45. It was at 74.48 on Nov. 23, the weakest level since the gauge started in 1973.

The only way out, unless the Fed reverses course soon or the dollar soars, is to adjust the currency regime with either a free float, revaluation or the adoption of a currency basket, Barrow wrote.

Speculation of a Gulf-wide revaluation is rising before a meeting between Saudi Arabia's advisory council, the Shura, and the finance ministry and central bank, according to Barrow. Saudi Arabia is blocking other Gulf states, such as the UAE and Qatar, from revaluing their currencies, he said.

The meeting will take place on February 17, a newspaper reported at the weekend. The authorities do not have to act on recommendations from the council and, of course, the council might not even recommend any currency change, Barrow wrote.

Kuwait became the first GCC state to drop its currency peg to the dollar in May, linking it to a basket dominated by dollars but including the euro, yen and British pound.

Saudi Arabia, the largest Arab economy, cut its benchmark rate for deposits by half a percentage point to 3% on January 31, while Kuwait and the UAE lowered their repo rates by the same amount to 3.5% and 3%, respectively.

Qatar and Bahrain reduced their deposit rates by half a point to 3%. Oman cut its repo rate 0.18 percentage point to 4.14% today, Dow Jones reported.

Traders see a 74% chance the Fed will lower its target for overnight bank lending by half a percentage point to 2.50% at its March 18 meeting, futures on the Chicago Board of Trade show. That compares with 70% yesterday and 14% a week ago.

Central banks can take other measures to try to limit the damage, such as raising reserve requirements, but we are skeptical that this works and we are also concerned that such tactics can adversely affect the banking sector,Barrow said.

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