UN says GCC could lose from revaluation

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UN says GCC could lose from revaluation

Post by orlandosf on Tue Jul 08, 2008 7:03 pm

UN says GCC could lose from revaluation

By
Nadim Kawach on Tuesday, July 08, 2008

The UAE and its partners in the Gulf Co-operation Council (GCC) could suffer heavy financial losses if they opt for a revaluation of their currencies against the ailing US dollar, according to a United Nations group.

A steady decline in the dollar against other major currencies allied with a spate of US interest rate cuts and soaring inflation in the region to push the GCC oil producers into a difficult situation and spur an intense debate on whether to keep their currencies pegged to the dollar, the Economic and Social Commission for Western Asia (ESCWA) said in a study released yesterday.

But the report said it believed regional governments are still reluctant to appreciate their currencies against the weak dollar on the grounds this would hit both their dollar-based foreign assets crude oil exports.

ESCWA noted that the GCC, which controls nearly 45 per cent of the world's recoverable oil resources, are also in possession of massive overseas investments as a result of their swelling current accounts surplus.

It estimated the assets of two GCC sovereign wealth funds (SWFs) – the Abu Dhabi Investment Fund (Adia) and the Kuwait Investment Authority (KIA) – at nearly 20 per cent of the total global SWF assets.

"The combination of accelerating domestic inflation, a continuous weakening of the dollar against other major currencies and recurrent cuts in the Federal Reserve's benchmark rates has led to an intense policy debate on the appropriate monetary and exchange rate policies for the GCC," it said.

The ESCWA report said the debate coincided with plans by the six GCC states to create a landmark monetary union in 2010, adding the project had received a severe blow when Oman decided to pull out in 2007. It also referred to Kuwait's decision to quit the dollar and revert to a basket of currencies as a peg to its dinar.

"As a result, GCC monetary authorities face a serious policy challenge, namely: they can keep following the Federal Reserve moves and reduce benchmark interest rates at a time when strong economic growth and increasing inflation rates would instead require a tightening of monetary policy; or they can allow a widening spread between domestic and US interest rates, thereby stimulating capital inflows and possibly further increasing the upward pressure on national currencies.

"In the light of that dilemma, a growing number of analysts and policy experts have suggested a move to more flexible exchange rate regimes such as replacing the dollar peg by a peg to a basket of goods."

It said that a less radical monetary policy option would be a one-time revaluation of national currencies against the dollar, which has been a common peg to most GCC currencies for more than two decades.

"However, fiscal and monetary authorities remain reluctant to such a move, given that it reduces the value of oil exports and foreign reserve assets and, moreover, that it further complicates monetary integration. They have repeatedly emphasised that the dollar pegs will remain in place, and that the current turbulences and speculations are only a temporary phenomenon."

GCC states – UAE, Saudi Arabia, Kuwait, Qatar, Bahrain and Oman produced around 15.5 million barrels per day of oil during the first half of this year.

The oil exports by GCC countries are priced in US dollar and they provide them with more than two thirds of their total income.

A large part of their investments abroad are also based in the US and this could interpret their hesitation to appreciate their currencies against the greenback.

According to ESCWA, which groups the GCC and other countries in the Middle East, Gulf governments have transferred a large part of their surplus funds over the past five years to their SWFs or stabilisation funds.

Its figures showed Adia and Kia alone controlled more than $1 trillion and accounted for nearly a fifth of the total assets of the SWFs worldwide.

Experts agree that any decision now by GCC states to adjust their currencies upward against the dollar could have negative rather than positive effects.

"In our view, the costs of changing the exchange rate far outweigh the benefits, particularly as imported inflation is an insignificant part of the current inflation story in the region," said Brad Bourland, chief economist at Jadwa, one of the largest investment consultancy firms in Saudi Arabia.

"Changing the peg to the dollar may make sense over the long term, as the economy diversifies and central banks develop a need for more independent interest rate setting tools. That time is not here yet, and changing the exchange rate primarily to chase dollar movements would now do more harm than good."

In a study, Bourland warned any sudden decision by GCC authorities to revalue their currencies would depress their foreign assets.

Another negative outcome is that their oil sales are priced in dollar and an appreciation means lower crude export earnings in local currencies, he said.

"This will again put pressure on their fiscal systems and could create budget deficits when regional states have just reverted to surpluses after painful shortfalls for more than two decades," said the Jadwa economist.

"In Saudi Arabia for example, oil revenues are earned in dollars and converted into riyal for budgetary spending. A revaluation would permanently impair the riyal value of oil revenues, reducing the size of the current budget surplus and accelerating the day when the budget falls into deficit… the value of the government's mostly dollar-denominated foreign assets, currently in excess of $300 billion, when converted into riyals would also be cut."

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