Gulf Depeg may not Yield Quick Fix

A decision by Gulf states to drop their currency pegs to the dollar is unlikely to provide a “quick fix” to slowing inflation as a similar move by Kuwait has only had a small impact in fighting price increases, an IMF official said.
Kuwait has allowed the dinar to appreciate 7.6% against the dollar since it dropped its dollar peg in favour of a basket of currencies, including the euro, the yen and the pound.
Inflation has since accelerated to 9.5% from 5.3% last May.
“A basket for Kuwait has probably worked, but at the margin,” Mohsin Khan, International Monetary Fund regional director for the Middle East and Central Asia, said in an interview in Dubai yesterday. “There is a view that Kuwait’s inflation could have been much higher had they not dropped the peg.”
Gulf states, including Saudi Arabia and the United Arab Emirates, have been under pressure to follow Kuwait and drop their pegs after inflation hit record levels. They have all kept their links, citing the need to keep currencies fixed until they form a monetary union in 2010, and the limited inflationary impact of the weak dollar.
“It’s very tempting to say” that revaluation would provide a “quick fix” for inflation, said Khan, who was in the region to mark the IMF’s release of a report on regional growth. Gulf currencies’ dollar pegs are “a part of it, but a small part,” he said.
Inflation in the UAE accelerated to 10.9% in 2007 from 9.3% in 2006, according to National Bank of Abu Dhabi, the country’s second-largest commercial bank by market value.
Consumer prices in Qatar rose an annual 13.7% in the fourth quarter, the highest rate of inflation in the region.
“The driving force behind inflation in these countries is supply side factors like rents, housing, supply shortages, absorptive capacity constraints, to some extent imported inflation and most recently food prices,” said Khan.
The UAE and Qatar, the two Gulf Arab states most likely to revalue their currencies according to trading in forward contracts, ruled out any change to their currency regimes in April causing investor speculation to fall.
Meanwhile, the IMF’s report on regional growth said the economies of the Middle East and Central Asia may grow by 6% this year, slightly slower than 2007.
“The key macroeconomic policy challenge in the short run for most countries in the region is to contain rising inflation,” Khan said.
Almost all of the 30 countries studied, which include oil-exporters Saudi Arabia, Algeria and Kuwait, have largely been unaffected by the recent financial turmoil in the US.
Khan said inflation is a concern in the oil-exporting countries that have greatly benefitted from record oil prices that have helped spur rapid economic growth.
“In oil-exporting countries with currencies pegged to the US dollar, it will be a challenge to control inflation as long as there is monetary easing in the US and a weakening US dollar, especially if the price of imported goods, in particular food, continues to rise,” Khan said. Khan said economic reform remains a top priority across the region regardless of the current benign economic conditions.
“For most countries, competition and efficiency would be enhanced by restructuring and privatizing inefficient state banks, by developing local debt markets, and by encouraging the establishment of foreign banks,” Khan said. – (via Gulf Times Qatar)