Gulf Banks Debating Currency Peg

06/19/2013 7:00 am EST

Focus: CURRENCY

Currency pegs linking Qatar, Saudi Arabia, and the UAE to the US dollar have come into focus at banks, as comments from Qatar's central bank governor suggest that changes to longstanding fixed exchange rates are being considered, writes Gregor Stuart Hunter of The National.

Banks have reignited the debate over whether Arabian Gulf states should peg their currencies at a fixed rate to the US dollar, after remarks from Qatar's central bank suggesting some should examine alternatives.

Last week, its director of research was quoted by Reuters as saying that Gulf states should consider a more flexible exchange rate. But Qatar's central bank governor, Sheikh Abdullah bin Saud Al Thani, said the country planned no change to its peg.

However, as financial markets became more intertwined, such a move might be considered, he told the news agency.

"With increasing integration in international trade, services, and asset markets, a higher degree of exchange-rate flexibility may become more desirable to ensure external stability and international competitiveness of our exports," Al Thani said.

Qatar is battling against accelerating rates of inflation, which increased 3.7% in April compared with the same month a year earlier to reach the highest level since 2009.

Saudi Arabia and the UAE have pegged their currencies to the dollar for decades. Kuwait, meanwhile, links its dinar to a basket of international currencies.

But the fact that such a move was being discussed publicly at all was "a deviation from the usual rhetoric", said Marios Maratheftis, the head of macroeconomic research at Standard Chartered. "There's been nothing discussed on the currency front for a few years."

Gulf states' currency pegs had served them well, and current inflation metrics were sufficiently benign that there was no need for a tweaking of official exchange rates, said Giyas Gokkent, the chief economist at National Bank of Abu Dhabi.

"Anchoring the currency makes sense," he said. "It gives stability and visibility for business contracts. There are good arguments for having the US dollar as an anchor currency and a peg."

The primary argument against a dollar peg is that it imports inflation from other economies when the Gulf states' monetary policy requirements diverge from those of the US Federal Reserve, Gokkent added.

In 2007, when the question of the Gulf states' peg last reared its head, the US was cutting interest rates at a time when the UAE was booming and experiencing double-digit inflation.

"A significant proportion of inflation, at least in the UAE and Qatar, was due to structural issues such as housing shortages, and wasn't something that monetary policy could have fixed," he added.

Currency forward contracts have already priced in a "very, very tiny knee-jerk reaction" to the comments, said Ehsan Ahmed, the regional head of foreign exchange, rates, and commodities trading at Standard Chartered.

Qatari riyal forwards indicated an expectation that the spot rate would be slightly higher than its current level a year from now, he added. But UAE dirham and Saudi riyal forwards also moved on the news, reflecting speculation over exchange-rate flexibility elsewhere in the region, Ahmed added.

Standard Chartered is recommending that Gulf states move towards a peg using a basket of reserve currencies, including the dollar, the euro, and the yen, but later incorporating the Korean won and the Chinese yuan, to better reflect the increasingly diversified trading patterns of the GCC states.

"Currently there is no pressure on the peg. But the best time to change the currency regime is when there's no pressure," Maratheftis said.

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