Gulf currencies need not revalue

Economist says GCC countries can continue pegging to the dollar despite inflation.

    The US dollar has remained steady against Gulf currencies but has lost much ground to the British pound and other world currencies [GALLO/GETTY]

    For the last six months there has been mounting pressure on Gulf countries to revalue their currencies with respect to the US dollar.

    Given that most of the Gulf currencies have been pegged to the dollar for more than 30 years - during which time there have been many economic and political upheavals - it is not likely that they are going to change the value of their currencies in response to current financial problems.

    Moreover, the Gulf Cooperation Council (GCC) plans a common, unified currency by 2010. Why rock boats now?

    The principal argument for revaluation is that the depreciation of the dollar has brought inflation to the Gulf countries.

    According to statistics from the central banks of GCC countries, inflation rates are up.

    Qatar's inflation rate has been the highest, measured up to the third quarter of 2007, at 13.8 per cent.

    According to the Abu Dhabi National Bank, the UAE's inflation rate stood at 10.9 per cent during 2006, the last reported statistic from the central bank.

    For the 12-month period ending March 2008, Saudi Arabia's Monetary Agency reported an inflation rate of 5.4 per cent. Though not really a substantial inflation rate, it is nevertheless relatively high when compared to recent statistics from the Saudi Kingdom.

    Cost of imports

    The dollar has weakened against the Euro and
    British pound affecting GCC imports
    The argument that the depreciation of the dollar brings about inflation is straight forward: as the dollar loses value against the Euro and Sterling Pound, the cost of importing Belgian chocolates, British pharmaceuticals, Dutch vegetables, French perfumes, and Italian clothes goes up in the GCC countries.

    But what proportion of the imports of the Gulf countries are from the UK and Western Europe?

    It ranges from 37 per cent for Qatar to 29 per cent for the UAE.

    Kuwait is a particularly interesting case. Kuwait imports about 30 per cent from the UK and Europe, and it is the Kuwaiti government which chose in May 2007 to switch from pegging the Kuwaiti Dinar to the US dollar to a basket of foreign currencies.

    However, in the third quarter of 2007 according to the Central Bank of Kuwait, the country's inflation actually rose to an annualised rate of 7.4 per cent compared to an inflation rate of 5.6 per cent during the first quarter when the Kuwaiti dinar was pegged to the dollar alone.

    Construction boom

    Another theory holds that inflation is caused by external surpluses denominated in dollars and earned from exports of oil and natural gas.

    When converted to riyals, dirhams, and dinars, the surpluses would increase the foreign asset holdings of the respective central banks.

    The central banks will then have to increase their money supplies denominated in local currencies to balance the dollar inflows.

    That will cause inflation. But this particular economic theory does not apply to the Gulf countries because the dollar surpluses do not even make it to the central banks.

    For example, in 2007 Saudi Arabia had a balance of payment surplus of almost $9 billion but the foreign asset holdings of the Saudi Arabian Monetary Agency increased by less than $1 billion. It is the same story for the other GCC countries.

    Where do the dollar surpluses end up? Significant portions end up in the Sovereign Wealth Funds where they remain denominated in dollars waiting to be invested abroad.

    But the leading reason behind the higher inflation rates of the Gulf lies in the housing and construction boom. According to their respective central banks, housing and rent costs went up about 26 per cent in Qatar in 2006 and about 15 per cent in the UAE for the same year.

    Housing carries a lot more weight than food, clothing, or transportation in the Consumer Price Index, and it is the latter set where the imported goods from the Euro and the sterling zones lie.

    A construction boom in the Gulf very soon runs into supply constraints in material and equipment.

    Thus, the prices go up because of supply constraints, not because there is excess money.

    Revaluation is harmful

    At this point in time, a revaluation of the foreign exchange rate will actually be harmful to many fledgling industries in the Gulf, which are trying to acquire international competitiveness.

    Suppose that Qatar Paints produces a can of paint for 36.5 Qatari Riyals (QR). At the current exchange rate of 3.65 QR to the US dollar, that container of paint can be exported for $10.

    If Qatar has a domestic inflation of 10 per cent, then the can of paint will cost 40.15 QR to produce and will have to be exported at $11. Thus, because of the 10 per cent inflation, the Qatari Riyal has already appreciated in real terms.

    If, the QR is then revalued by 10 per cent - setting the exchange rate at 3.28 QR per dollar - then the can of paint which now costs 40.15 QR to produce will have to be exported at $12.20. This leades to a further loss in external competitiveness.

    Countries like Bahrain, Kuwait, Qatar, Saudi Arabia, and the UAE are trying to diversify from oil and natural gas. A revaluation will hurt these infant industries which are trying to export new products to new foreign destinations, or trying to compete against imports.

    While it is true that a revaluation would have helped the Gulf withstand the increased cost of importing British and European goods, it is more prudent to focus on the more important reason for inflation, namely the housing and construction booms.

    In addition, the Gulf authorities have kept their economies insulated from their oil surpluses, thereby preventing a sharp increase in their domestic money supplies.

    A revaluation now will make non-oil exports from the Gulf more expensive, and non-oil imports cheaper, which will harm the GCC's nascent domestic manufacturing industries.

    Adhip Chaudhuri has been a faculty member of the Georgetown University's School of Foreign Service since 1979. He is a visiting professor at Georgetown University's campus in Doha, Qatar.

    The views expressed by the author are not necessarily those of Al Jazeera.

    SOURCE: Al Jazeera


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