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US ports deal: A bitter aftertaste

First published in:
Al Jazeera

Rutledge, E. J. (2006, August 19). US ports deal: A bitter aftertaste. Al Jazeera. https://www.aljazeera.com/news/2006/4/19/us-ports-deal-a-bitter-aftertaste

As a consequence of the furore by the US congress over DP World’s acquisition of several American ports, the Dubai state-owned company decided to avert a long legal battle and agreed to put these assets up for sale.

That DP World had already sought and obtained the necessary US regulatory approvals did little to temper the irrational concerns expressed by many American commentators.

Congressional concerns were not over DP World’s business plan or its security record – the US navy has been using Jebel Ali for more than 15 years – but were almost exclusively because it was an Arab company. It is clear, though, from a brief review of the regional and international press, that the consensus view is that congress was unnecessarily discriminatory and in the wrong.

It happens that many other US ports are owned and/or operated by foreign companies, many of which are Asian. According to the New York Times, foreign-based entities own over 30% of America’s ports. Over 80% of Los Angeles’s port terminals are run by foreign companies. A Singapore state-controlled company operates Pacific coast ports from Los Angeles to Alaska.

In a similar incident last year the Chinese energy company CNOOC had to give up its bid to take over Unocal as a result of US congress disquiet. At the time America was accused of hypocrisy. On the one hand it was, and still is, advocating free trade as the global panacea and on the other protecting its own back yard; the DP World affair will only compound this sentiment. In other respects America is likely to lose out from its treatment of DP World.

There is little doubt that the decision will deter other GCC investors from US acquisitions. America will also find it harder to win support for its much-hyped Middle East free-trade area and at the very least the timetable for negotiating a free-trade agreement with the UAE will be put back.

Advantage Dubai

DP World expects to raise about $750m from the sale of its recently acquired US assets. Its US ports business operates five container terminals and handles cargo and passengers at a number of other sites. Since these operations accounted for around 10% of P&O’s annual global turnover and are less profitable than other operations in emerging markets, the company will make a tidy profit if it realises its asking price.

The US ports sector can hardly be viewed as having as high a growth potential as P&O’s Asian assets, as it is a mature market. The forced sale will also mean that the company will have more money and time to concentrate on the more lucrative emerging markets of Asia.

Despite the sale of its US assets DP World is now the third-largest port operator in the world. DP World has gained huge amounts of free publicity and a fair deal of sympathy. The company, which is borrowing $6.5bn to fund its takeover of P&O, had received commitments of over $14bn by March 20 and this is a clear sign that the episode in America has done nothing to dampen investor confidence in the company’s future prospects.

Although on a much smaller scale, it is somewhat ironic that another government of Dubai-controlled investment body, Istithmar, has bought into the US ports business this year. In January Istithmar bought Inchcape Shipping Services for $285m. Inchcape has various interests in America and, for instance, works with the customs department in the key ports of New York and San Francisco.

Turning to the UAE-US free-trade agreement, on the face of it the US stands to benefit more than the UAE from a bilateral agreement. US companies stand to gain in the short term, as most bilateral trade comprises US exports to the UAE. If the agreement fails as a result of the DP World fiasco, it would represent a considerable blow for American economic interests.

Nevertheless, the UAE will no doubt act pragmatically and if it considers the longer-term benefits of a free-trade agreement, such as increased levels of US inward investment, as credible, it is likely that it will still go ahead. GCC states will still invest in the US, but may decide to do so in the more traditional behind-closed-doors fashion.

By forming partnerships and not seeking to acquire controlling stakes, GCC investment bodies can make strategic investments without incurring political costs. According to an Abu Dhabi Investment Authority executive, the authority is not going to stop buying assets in the US, however ADIA will increasingly be looking East for longer-term investment opportunities.

Disadvantage USA

US misguided anti-Arab sentiment will not only tarnish America’s reputation as a free-trade nation but by making it harder for Arab governments to invest in the US may well deter the process of petrodollar recycling – something which since the collapse of Breton Woods has greatly benefited the American economy.

Sultan Bin Nasser al-Suwaidi, the UAE’s central bank governor, said that “trade and investment relations with the United States must now be viewed from a new perspective”. Many analysts, including some from the US, have said that the DP World affair may set a damaging precedent and deter investors, particularly from the Middle East, from investing in the US.

The US economy would inevitably suffer if petrodollars did not filter back into its economy and were instead converted into euros or yen. Mohammed Sharaf, the DP World chief executive, recently said that other foreign companies could be put off investing in the US by DP World’s experience, especially oil-rich Arab states.

Asian exporting economies and Opec states seem less willing simply to hold their US dollar assets in treasury bonds and are looking for better returns by buying fixed assets such as companies and property.

For example, another Dubai government-owned company, Dubai International Capital, is in the process of buying Doncasters, a UK-based aerospace manufacturer, for $1.2bn. The takeover is relevant because Doncasters has various interests in US military weapons programmes, including the Joint Strike Fighter.

Dubai International Capital’s takeover of Doncasters has yet to receive much media attention in America, but if it does and the attention is similar to that DP World received it will further tarnish America’s free-trade reputation and the US will be seen as increasingly hypocritical.

[As Aljazeera then put it: “Emilie Rutledge is a British economist who is currently based at the Gulf Research Center in Dubai”]

Sukuk Rising Fast in Popularity

First published in:

Rutledge, E. J. (2005, November 3). Sukuk Rising Fast in Popularity Arab News. https://www.arabnews.com/node/282634

The Islamic bond (Sukuk) is fast rising in popularity and so lucrative is the potential market that conventional international banks are falling over themselves to set up Shariah-compliant operations. With abundant oil-windfall revenues and a raft of infrastructure mega projects either underway or on the drawing board, the Gulf is fast becoming the logical choice for new and established players alike to set up shop.

As conventional bonds are “off limits” to Muslims because interest is paid to those who invest in them, the Gulf debt market was until recently underdeveloped. This is changing because Sukuk offer a share in the proceeds from a business venture rather than paying out interest.

Bahrain has been a leading “offshore” banking center for decades and its central bank, the Bahrain Monetary Agency, is one of the pioneers of Islamic banking. However, until recently, the “capital” of Islamic finance was Malaysia. Competition is certainly building up, Swiss banks are now making efforts to understand, embrace and implement some elements of Islamic finance and the UK’s chancellor of the exchequer, Gordon Brown, has said that he wants London to become the global Islamic finance center.

The latest Sukuk deal from the Gulf Cooperation Council (GCC) bloc is Saudi Basic Industries Corp’s (SABIC’s) $800 million issue. This is significant because it is the first Saudi Sukuk to be issued under the new Capital Market Law and the debt market in the Kingdom is relatively untapped. If SABIC becomes a Saudi trendsetter, there is no doubt that the GCC will become the global hub for Islamic finance. The only question is if the likes of Merrill Lynch and Goldman Sachs will pitch their headquarters in Dubai, Manama or Riyadh? According to the Islamic Finance Information Service, there were three key players in terms of issuing Sukuk in 2005 — GCC countries, Malaysia and Pakistan. To date, most Sukuk have been corporate, not sovereign. For instance, the only major sovereign bond issue in the GCC countries during 2005 was by the government of Bahrain ($79.5 million). It therefore follows that the potential Middle Eastern sovereign Islamic bond market could be huge in the future.

In 2005, a Malaysian company, Jimah Energy Ventures, issued the largest Sukuk for the year — $1.27 billion; Malaysian companies also issued the second and third biggest Sukuk last year (Musyarakah One Capital’s Sukuk for $658 million and PLUS Expressway’s for $634 million). However, the tables turned in early 2006 with DP World launching the largest Sukuk in history. The $3.5 billion issue by Dubai Ports, received more than $11 billion in subscriptions! The Malaysian bank, Commerce International Merchant Bankers, was the leading Sukuk manager (as of Q2 2005) with $1.39 billion, but the UAE’s Dubai Islamic Bank was in third place having managed three Sukuk worth $633 million. Interestingly, and indicative of the trend in conventional banks moving into Islamic finance, HSBC Amanah was last year’s second most important Sukuk manager having helped various entities raise $ 882 million, in seven separate issues.

The overall pool of assets managed by Islamic banks, according to estimates by Reuters, is between $250 billion and $400 billion. Over the past five years the Sukuk market has grown significantly — the latest data from Bahrain’s Liquidity Management Center indicates that there is almost $ 18 billion worth of outstanding issues; of this, no less than 52 percent originates from the GCC countries.

Various changes have taken place or continue to take place and all bode well for the Gulf’s nascent financial centers. The first is that much more of the region’s oil windfall revenues are being retained within the region than in previous oil booms. Ongoing reforms, particularly in the region’s real estate sectors, are attracting significant levels of this retained capital. The second is the region’s increasingly bullish private sector. All regional governments are investing heavily in their respective infrastructures and unlike the past, most of today’s projects are generating growth, and not white elephants.

Thirdly, governments and regulators in various GCC countries are being proactive in promoting Islamic banking and are developing custom-built regulatory frameworks, rather than simply following Malaysia’s lead. Combined, these changes mean that more local entities are seeking to raise money via Sukuk issuance and domestic investors are more willing to invest in such bonds. Many of the Sukuk issued in the Gulf till now have been oversubscribed due to high demand, but many more are in the pipeline. The head of Islamic Finance at the Dubai International Financial Center, Khalid Yousaf, estimates that the GCC countries are likely to see another $9 billion worth of new Sukuk between now and the end of the year. Many of the Gulf Sukuk that are open to foreign subscribers are not just attracting Middle Eastern and Asian investors, but increasingly European and US ones too. Furthermore, Western companies are also starting to seek Islamic debt. For instance, the Gulf East Cameron Partners from the United States recently became the first American firm to issue a Sukuk ($166 million).

As the sophistication of Shariah-compliant products increase (particularly the emergence of a secondary market for trading issued Sukuk, as is happening in Dubai and Manama), a far higher number of Muslims and Islamic countries will opt for Sukuk as opposed to conventional bonds. And, why not? For all intents and purposes, the financial returns are comparable; the only real difference is that one is just that bit more ethical than the other.

(Emilie Rutledge is an economic researcher at the Gulf Research Center in Dubai.)

The dollar declines, while the euro shines

First published in:

Rutledge, E. J. (2006, May 28). The dollar declines, while the euro shines. Khaleej Times. https://www.khaleejtimes.com/business/the-dollar-declines-while-the-euro-shines

The dollar is once again losing value, and has depreciated by seven per cent against the euro since the start of the year. How far it will go is anybody’s guess, but the odds are, it will fall further.

Li Yong, China’s Vice-Minister of Finance, has talked of a possible further 25 per cent fall. According to some estimates the amount the United States now owes to the rest of the world now stands at $3 trillion. This, not anything else, is the prime reason for the dollar’s decline.

Although the Federal Reserve does not want to see the dollar collapse, it probably views any dollar devaluation as a convenient way of partially reducing the US’ huge current account deficit. If the dollar declines so will the ‘value’ of the deficit. However, a falling dollar does not bode well for the GCC. It will exacerbate inflation as European and Japanese goods become more expensive and it will also result in a depreciation of the ‘real’ value of the region’s reserve holdings. In addition, because oil and gas are priced and sold in dollars the GCC also stand to loose some revenues in this respect also.

Nevertheless, we have seen only a limited response to these currency conundrums in the form of Kuwait’s decision to allow its currency to appreciate marginally against the dollar. There has been talk from several of the region’s central bankers about a possible realignment in their foreign reserve holdings but as yet no concrete action has been announced. For the time being at least, any speculation that other GCC states were about to follow Kuwait’s lead have been discounted. Both the Saudi Arabian Monetary Authority and the Central Bank of Oman came out and publicly defended the status quo.

Apart for arguments such as ‘providing stability’ and ‘eliminating intra-regional exchange rate risk’ (all 6 GCC states are pegged to the US dollar, albeit Kuwait maintains a more flexible band within which to fluctuate), there is another argument for maintaining the dollar peg. And that is that the collective peg is an interim step towards forming a single GCC currency in 2010. Having a joint peg is a good thing, as it eliminates exchange rate risk within the bloc, but it could just as easily be achieved with a joint peg to the euro or a trade weighted basket of currencies.

Happy creditors no more? For many years Asian central banks, particularly those of China and Japan, have been willing to finance US deficits despite the risks, in order to support their own export-led growth models. However, the scale of financing (subsidising) required to sustain the US’ current account deficit may soon exceed their absorptive capacities. A law of diminishing returns also comes into play; there comes a point when alternative economic growth models look more appealing that accumulating ever greater numbers of underperforming US Treasury Bonds.

The current situation is somewhat perplexing, the country that controls the world’s de facto reserve currency, also happens to be the world’s largest debtor. In any other walk of life, you would be forgiven for being somewhat wary if lending to someone with huge debts. The US like any other debtor may be tempted to use (or not do anything much to prevent) devaluation to reduce external deficit, and this is hardly a desirable trait for a reserve currency.

The dollar has been the dominant reserve currency for at least the past half century and will no doubt continue to be one for some time to come. It can however no longer take this role for granted. One thing is constant in history and that is nothing remains the same forever. Back in the early 1990s after a period where the dollar devalued considerably, many economists at the time speculated about the dollar’s role as the world’s de facto reserve currency. The dollar, nevertheless rebounded, and continued to play its role, in part because there was no viable alternative.

This has changed. Today we have the euro (tomorrow perhaps, even the Yuan). In general for a currency to qualify as a reserve one it needs to meet several criteria including being backed by a large economy, which itself has free flows of capital, open and deep financial markets and low inflation. The euro zone has all of these characteristics and to top it all, it runs a current account surplus.

Those who switch first stand to gain the most: It is now estimated that the US’ deficit consumes no less than two thirds of the worlds total current account surplus. Joseph Stiglitz, a f ormer head of the IMF, recently pointed out that there is obviously something peculiar about a global financial system in which America borrows more than $2 billion each and every day from other countries (in March the US’ Trade Deficit was $62bn) whilst lecturing them on fiscal responsibility.

One could view the current state of affairs as a bit like the classic ‘prisoner’s dilemma’. If any one Asian central bank switched its reserves into euros tomorrow it would undoubtedly benefit vis-à-vis the others, but if they all attempted to switch at the same time they would collectively see the value of their reserves fall considerably, as the resulting run on the dollar would adversely affect all that hold it in reserve.

Reactionary tendencies will probably mean that the GCC dollar peg remains for the time being but there is a strong and growing argument for a move away from too much dependence on the dollar. If Gulf central banks were to buy euros today with some of their dollars reserves, they would get far better exchange rates than if they were to wait for Asian central banks to make the move first.

It is surely worth the while of the GCC’s central bankers to seriously consider alternative options to the current status quo, it would be a shame if the considerable economic achievements of the past few years are washed away by maintaining a rigid dollar peg that may be extremely expensive to maintain and cause unnecessary inflation.- (Emilie Rutledge is an economist with Gulf Research Centre)

To peg or not to peg: that is the question

Calls to scrap the GCC’s fixed relationship with the dollar have to reckon with the alternatives.

May 1, 2006 | Gulf News | Andrew Shouler

https://gulfnews.com/business/sectors/features/to-peg-or-not-to-peg-that-is-the-question-1.235046

If you are invited to a presentation about corporate ethics hedging, it may take you a moment to grasp the concept. Since ‘ethical investment’ has become an established term, the phrase actually trips off the tongue. However, I’m glad to say it didn’t sound right when I heard it down the telephone. It suggested something implicitly like the route to an Enron-type result. Even if a company wanted to ‘hedge’ its ‘ethics’, would there be anyone proudly advertising such a service, let alone a well-known and reputable institution?

Better, of course, to hear clearly what you’re being told. Corporate FX hedging is the name of the game, and Standard Chartered Bank is talking that book. The much-awaited US dollar slide may be under way, and there is business to be had in offering protection against such foreign-exchange risk exposure.

That’s not the most interesting bit of the bank’s recent research report, however (in case you were wondering). It’s not even the second most interesting bit which, to me at least, was the forecast of the British pound falling even against a falling dollar over the course of the year. (The idea that the UAE dirham might still rise against sterling makes dollar-equivalent earnings less troubling to a British expat.)
And, on an infinitely bigger scale, that is the kind of issue which is the real story. It’s about not only risk, but real returns, to the Gulf countries as a whole.

Standard Chartered Bank recommends that the proposed GCC single currency should de-peg from the US dollar. It is not alone in that. The Dubai Chamber of Commerce and Industry implied as much in an economic bulletin a year ago, saying that floating would allow independent policy-making and avoid the same fate as the dollar.
The Gulf Research Center in Dubai has been discussing the issue on and off for some while.
Indeed, many have wondered aloud on this topic, while not all committing to a verdict. But the bank has repeated it, again, and argued a case.

Decision
If such a decision came, it would undoubtedly be a bold step, with significant implications. The currency itself may still be some way off, with occasional rumours that the 2010 deadline is in doubt. Yet, though timing is undoubtedly important (and especially so if the problem to be resolved is here and now), that’s actually not the key point.
Why, in fact, suggest such a radical step for a region whose currencies have mostly been pegged to the dollar for decades, which has not been especially troubled in doing so, and indeed now appears to be flourishing?

The bank’s reasoning, amid its carefully-defined research, boils down to two points, both easily accessible.

First, it is not in the best interests of the Gulf countries for their currencies to go down with the (apparently) sinking ship which is the dollar. While exports are mostly dollar-denominated, imports are substantially in other currencies, which would therefore become more expensive. That’s clear enough, leaving aside for the moment the incendiary topic of whether oil should continue to be priced in dollars.

Second, running domestic monetary policy in line with US policy (i.e., setting interest rates in parallel to the US Federal Reserve) always runs a risk, namely that the policy stance is inappropriate (too lax or too tight) for local conditions. The trade-off between the confidence generated by the fixed relationship on the one hand and policy inflexibility on the other is the core conundrum, and an increasingly live issue now, when interest rates seem considerably too low for the Gulf’s rampant economies.
They explain it further. The decline of the dollar against the euro through 2000-2004 increased the GCC’s import bill. The subsequent decline against Asian currencies too, projected to continue, represents a further “threat to the bottom line”. That currency mismatch applies also to budgets, where revenues are also mostly dollar-denominated, but spending frequently is not.
At the moment, whereas the dollar peg brings useful certainty vis-à-vis the dollar, with the hydrocarbon sector still so dominant it means that the impact of oil-price fluctuation is imparted fully to the real economy. Some form of currency float would allow the exchange rate (and interest rates) to take some of the strain.

Theme
Moreover, “Forex diversification is likely to become an increasingly important theme going forward” at the global level, so that having 90 per cent + of reserves in the dollar “is not necessarily appropriate any more”. A couple of diplomatic euphemisms there. In layman’s terms, if Asian central banks, Russia and others are going to flee the dollar, it may be better to be with them rather than trying to hold the fort.

“We believe the dollar is overvalued, and therefore could be subject to a significant correction,” says Standard Chartered. While that forecast appears cannily hedged itself, the warning is clear. The recommendation is that the planned GCC currency “should be marked against a trade-weighted basket instead”.

At one level, the logic is compelling. The idea that the Gulf region selling oil lucratively at $70 and in huge surplus should be tied to the dollar, with America in chronic deficit and buying expensively at the same price, does have a ring of absurdity about it. But is it as simple as that?

Stepping back, a barrage of advice has come over the years from the IMF (the same IMF which last week called for dollar devaluation). The outcome, however, has been inconclusive. While agreeing that a more flexible exchange rate policy may become desirable as the GCC economies become more diversified and integrated with world markets, it has generally found that a trade-weighted basket peg would be no better than a dollar peg in procuring stability, and the flexibility versus credibility debate becomes no clearer, though a euro/dollar combination may offer a reasonable alternative.

At the Gulf Research Center, economist Emilie Rutledge seems more convinced. As the “GCC’s economies are maturing and diversifying rapidly” the current inability to set their own monetary policy “is far from optimal”. Additionally, “as a longer-term investment the euro looks more promising than the dollar”.
She raises the further matter of the creation of a single GCC currency (the ‘Gulf dinar’) itself creating downward pressure on the dollar, as the oil-producing countries will invest more at home instead of (as previously) in dollar assets. The dinar may itself attain reserve status, especially if oil were priced in the same terms, though there would be “political disquiet” from the US in that event which is another understatement.
It should all give further pause for thought.
Wouldn’t the GCC states be prejudicing the value of their own existing reserves if they (effectively) acted against the dollar, whether by diversifying their assets, depegging, or pricing oil differently? In an environment of very high oil prices, could it actually be done without serious revaluation, which would jeopardise emerging non-oil activities and, ironically, call for (entirely inappropriate) lower interest rates? Not pegging risks the GCC tent being blown about by a potentially storm-force wind.
Standard Chartered Bank’s analysis suggests that flexibility will be manageable. The authorities could still offset current account inflows by capital outflows (though less into dollars), and would simply have to judge whether the exchange rate or interest rate were their priority.
So there it is. I’m not entirely convinced, but perfectly well accept that the GCC may have outgrown the peg. Meanwhile, it’s worth remembering that no exchange-rate regime on its own delivers a definitive economic framework. Fiscal control and structural matters remain beasts which have to be tamed for a successful, overall strategy.
Also, we are still talking about 2010. By my calculation, that’s getting on for four years away.
The dollar might still be ‘weak’ and the euro ‘strong’. We cannot know. But, won’t the markets have moved on a bit by then?
On the practical side, the European Central Bank is offering the GCC states advice, and their technocrats are probably among the least objectionable of the EU’s infrastructure. Whether the euro will appear in the policy mix is then an intriguing issue. Europe does not have much call for an even higher dollar exchange rate, but it does like gestures denoting prestige.

There’s another idea I could mention. If the GCC is on the lookout for another possible fix, like a ready-made US dollar & euro basket, it could consider a fairly heavyweight international currency which already fits that description. Despite the fact that it has been threatened with expiry, including by ministers and (almost hysterically) by so-called experts in its own country, it’s been around a very long time and it still works. It is far less volatile historically than either the dollar or the euro (see chart), because its balance of payments is relatively evenly exposed to both. You may even have heard of it. It’s called sterling: the British pound. Snag is: Standard Chartered do say it will fall faster than the dollar. Maybe. Anyway, it’s just a thought.

QUOTE
Hany Genena, Senior Economist, EFG-Hermes
Of course, de-pegging would imply appreciation of all GCC currencies. In 2005, the combined current account surplus of the six GCC states is estimated at approximately $160 billion, with net foreign assets in the banking system (excluding reserves accumulated in stabilisation funds) at approximately $260 to $300 billion.

With a positive outlook for crude oil prices over the medium term in addition to capital inflows, all GCC states will have significant appreciation pressures on their currencies. There is an important point to note here, though.

If the bulk of foreign currency inflows is channelled directly to central banks or stabilisation funds and re-invested abroad, then appreciation pressures could be mild.
De-pegging GCC currencies will not likely have a negative impact on the USD. Since GCC countries do not have enough investment opportunities domestically to absorb petrodollars, they will continue to find their ways into US Treasuries even after a revaluation.
In addition, unlike the case of China, currency revaluation in the GCC will not imply a decline in exports and a decline in accumulation of reserves, since crude oil exports are denominated in USD and are not sensitive to exchange rate movement. In fact, an appreciation of the GCC currencies could help resolve global imbalances by making US imports cheaper and reducing the deficit.

A shift in the demand for the USD by reallocating reserves, however, could indeed de-stabilise it. An outright exit from the USD by global central banks could indeed lead to its collapse. The cost of [the resulting] abrupt shock to interest rates in the US could be large. It could indeed lead to a global slowdown. I think that most GCC countries will opt towards a gradual shift in reserves.

Simon Williams, Senior Economist, Economist Intelligence Unit
De-pegging does make sense [for the GCCs], to run their own monetary policy. The inflationary situation at the moment throws that into very sharp relief. A lot of preparation would need to be done, including stopping pricing oil in dollars. Otherwise it risks compounding the volatility of the local currency value of oil revenues. The authorities would also have to guard very carefully against the kind of substantial appreciation pressures that there would undoubtedly be at the moment if the currency were floating.

Steve Brice, Regional Head of Research, Standard Chartered Bank
The key here is for the region to do what is best for the long-term sustainability of the region’s economic performance. We believe that authorities still have time to diversify reserves quietly before the new single currency comes into effect.
Forex reserves in fact are not the issue. The bigger issue is the investment agencies who are clearly large even in a global context. They would likely be discreet in their diversification efforts. However, the impact on the value of the dollar would be there for all to see.
[The interest-rate, exchange-rate trade-off] is a real challenge for the region, especially when taking into account the need to diversify the economies in order to create jobs for the hugely-expanding labour markets. In the short-term, this may create a conflict between managing the boom (higher interest rates) and help boost the diversification process (by ensuring a competitive currency). Clearly, the situation would need careful monitoring and managing.

On the issue of what currency to price oil in, we see no reason why an alternative currency/ies could not be used. If the GCC countries were to pursue a trade-weighted exchange rate target, then imagine the UAE, for instance, exporting to Europe. This would mean the importer would need to hedge its euro/dollar exposure and the UAE exporter would have to hedge its dollar/GCC exposure. Why not transact in either the GCC single currency or euro, which removes the need for one counterparty to hedge?

If [oil pricing] were in euro, the UAE would be able to naturally diversify its reserves away from a structurally weak dollar. Alternatively, it could price oil in dirham, and then make a rational investment decision as to what to do with that money.

Pierre Cailleteau, Senior VP, Sovereign Risk Unit, Moody’s
We do not make recommendations, but I am not entirely sure whether a change of policy would help fix the problem. I don’t really see an alternative regime that would be superior. If you have a flexible exchange rate, and it rises with capital inflows which create higher credit and inflation, then interest rates are raised, then the exchange rate rises again ? [It is a vicious circle.]

Practically, it may be better to endure the peg. It is the price paid for a less-than-perfect policy regime [like any]. Any country with high commodity dependence has this issue. In the case of Norway or Canada, the ratio is lower than here. The UAE [and GCC] are a special case, with a huge exchange-rate ‘overshoot’ and ‘undershoot’ possibility. In any case, it is unwise to shift from a fixed system to flexible without the rest of the policy framework and banking system being ready. Change could mean GDP would become even more volatile.

Gulf countries shifting funds to emerging markets

GCC countries are realigning their investment plans and ploughing their oil wealth in emerging markets instead of the western developed countries, says the latest report from a regional research body.

April 16, 2006 | Gulf News | Stanley Carvalho

https://gulfnews.com/business/sectors/markets/gulf-countries-shifting-funds-to-emerging-markets-1.233112

GCC countries are realigning their investment plans and ploughing their oil wealth in emerging markets instead of the western developed countries, says the latest report from a regional research body.

“The DP World debacle witnessed in America and currently unfolding in India should not and most probably will not deter the GCC’s foreign investment plans, but may herald realignment,” says Emilie Rutledge, economic researcher at the Dubai-based Gulf Research Centre (GRC).

“There is little doubt that the anti-Arab sentiment experienced by DP World will, to a certain extent, deter other GCC investors from seeking to acquire US assets. But more generally, Gulf governments are no longer happy to simply hold US Treasury bonds. Today, they are more interested in the return on their investments, and are more willing to take calculated risks and invest in key Asian growth markets such as China and India.”

For example, the Kuwait Investment Authority (KIA) is currently in the process of realigning investment in Organisation for Economic Cooperation and Development countries to emerging markets, noted the report, quoting Bader Al Sa’ad, KIA’s managing director.
The Gulf states plan to invest more revenues from oil sales in Asian countries to strengthen ties with their fastest-growing energy customers.

The Abu Dhabi Investment Authority (ADIA) and KIA is in the process of buying 10 per cent of the Industrial and Commercial Bank of China for a reported $2 billion. ADIA, one of the world’s richest investment bodies, is known to be looking to buy more assets in emerging markets, such as Chinese insurance and oil and gas companies as well as Indian financial services firms.

Dubai’s Istithmar is refreshingly open with regard to its strategies and acquisitions and has acquired a significant shareholding in SpiceJet, a leading low-cost airline in India, which was launched in May 2005. But despite some recent setbacks like the DP World case, the report suggests that the GCC countries should focus on acquiring assets abroad.

“GCC governments can and should do several things with current windfall revenues and surplus liquidity in order to mitigate the risks of future oil price shocks. The period of protracted economic stagnation suffered by the region for much of the 1980s and 1990s must not be forgotten. Apart from investing in infrastructure and human capital and moving into the value-added downstream energy industries, the GCC should concentrate on acquiring overseas assets.”

Oil prices ‘will stabilise this year’

Current trends indicate demand and supply will increase, says expert

by Mohammad Ezz AL Deen | January 16, 2006

During the Gulf Research Centre’s third annual conference recently, Anas Alhajji, moderator of the Gulf Energy Program-me at the GRC, said he expects oil prices to stabilise in 2006.

Prices will only decline significantly, he said, if the US falls into recession as a result of a decline in government spending. “The soaring price in 2005 was due to the market fundamentals of limited supply and rising demand. Opec members ran out of marketable excess capacity, and non-Opec production was lower than expected, while global demand especially in the US, India and China continued to grow,” Dr. Alhajji said. Current trends estimate that both demand and supply will increase in 2006. However, oil prices will depend on the size of the additional production capacity, he added.

According to experts at the Dubai-based GRC, the Gulf is likely to experience a period of high growth in 2006, a modest decline in oil prices, significant political developments, rising tension, and a slow shift in focus towards Asia in the realm of international relations.

Emilie Rutledge, econ-omist at the GRC, said that high oil prices and the increasing global demand for oil triggered a boom for the GCC economies. The region’s aggregate GDP rose by 5.3 per cent, stock markets grew by 79 per cent and market capitalisation touched $1.1 trillion, an increase of 110 per cent over 2004. The aggregate GCC trade surplus stood at $253 billion in 2005, and imports of good and services rose by 20 per cent, she said. “Regional governments are generally aiming to avoid over-dependence on oil through economic diversification strategies, labour nationalisation policies and the privatisation process,” she said.

Vital issues
GRC Chairman Abdul Aziz Sager highlighted important issues in 2005, including the continuing political reform process that has firmly implanted itself in the region, the effects of the unprecedented increase in oil prices on the GCC economies, as well as the numerous security challenges that confront the region. “Despite the economic and strategic importance it represents, the developments in the Gulf region during 2005 were not reassuring as far as the status of Gulf security is concerned,” Sager added.

The GCC defence budget amounted to $34 billion during 2005, a $4 billion increase over 2004. The budget growth could be related to higher revenues because of oil prices, said Mustafa Alani, Director of the Security and Terrorism Programme at the GRC.

Iran – a threat to the petrodollar?

First published in:
Al Jazeera

Rutledge, E. J. (2005, November 3). Iran – a threat to the petrodollar? Al Jazeera. https://www.aljazeera.com/news/2005/11/3/iran-a-threat-to-the-petrodollar

Iran’s decision to set up an oil and associated derivatives market next year has generated a great deal of interest.

This is primarily because of Iran’s reported intention to invoice energy contracts in euros rather than dollars.

The contention that this could unseat the dollar’s dominance as the de facto currency for oil transactions may be overstated, but this has not stopped many commentators from linking America’s current political disquiet with Iran to the proposed Iranian Oil Bourse (IOB).

The proposal to set up the IOB was first put forward in Iran’s Third Development Plan (2000-2005). Mohammad Javad Assemipour, who heads the project, has said that the exchange will strive to make Iran the main hub for oil deals in the region and that it should be operational by March 2006.

Geographically Iran is ideally located as it is in close proximity to major oil importers such as China, Europe and India.

It is unlikely, in the short term at least, that large numbers of energy traders will decamp and set up shop in Iran; a country which happens to be categorised as a member of the “axis of evil” by the president of the world’s largest oil-importing country; the United States.

But over time, Iran could take some business away from the two incumbent energy exchanges, the International Petroleum Exchange and the New York Mercantile Exchange who both invoice sales solely in dollars.

Economic motives

If successful, the IOB will provide Iran with concrete economic benefits especially if it invoices at least some of its energy contracts in euros.

Iran has around 126 billion barrels of proven oil reserves about 10% of the world’s total, and has the world’s second largest proven natural gas reserves.

From an economic perspective, invoicing oil in euros would be logical for Iran as trade with the euro zone countries accounts for 45% of its total trade. More than a third of Iran’s oil exports are destined for Europe, while oil exports to the United States are non existent.

The IOB could create a new euro denominated crude oil marker, which in turn would enable GCC nations to sell some of their oil for euros. The bourse should lead to greater levels of foreign direct investment in Iran’s hydrocarbon sector and if it facilitates futures trading it will give regional investors an alternative to investing in their somewhat overvalued stock markets.

Euro zone countries alone account for almost a third of Iran’s imports and currently Iran must exchange dollars earned from hydrocarbon exports into euros which involves exchange rate risk and transaction costs.

The decline in the dollar against the euro since 2002 – some 26% to date – has substantially reduced Iran’s purchasing power against its main importing partner.

If the decline continues, more states will increase the percentage of euros vis-à-vis the dollar they hold in reserve and in turn this will increase calls both in Iran and the GCC to invoice at least some of their oil exports in euros.

A move away from the dollar and a strengthening of the euro would further benefit Iran as according to a member of Iran’s Parliament Development Commission, Mohammad Abasspour, more than half of the country’s assets in the Forex Reserve Fund are now euros.

It is primarily the US which stands to lose out from any move away from the petrodollar status quo, it is the world’s largest importer of oil and a move away from invoicing oil in dollars to euros will undoubtedly have a negative effect on its economy.

Fewer nations would be willing to hold the dollar in reserve which would cause a significant devaluation and result in the loss seigniorage revenues. In addition, US energy-related companies stand to lose out as they will be unable to participate in the bourse due to the longstanding American trade embargo on Iran.

Political considerations

In the 1970s, not long after the collapse of the gold standard, the US agreed with Saudi Arabia that Opec oil should be traded in dollars in effect replacing the gold standard with the oil standard.

Since then, consecutive US governments have been able to print dollar bills and treasury bonds in order to paper over huge current account and budgetary deficits, last year’s US current account deficit was $646 billion.

Needless to say, the current petrodollar system greatly benefits the US; it enables it to effectively control the world oil market as the dollar has become the fiat currency for international trade.

In terms of its own oil imports, the US can print dollar bills without exporting commodities or manufactured goods as these can be paid for by issuing yet more dollars and T-bills.

George Perkovich, of the Washington based Carnegie Endowment for International Peace, has argued that Iran’s decision to consider invoicing oil sales in euros is “part of a very intelligent strategy to go on the offense in every way possible and mobilise other actors against the US.”

This viewpoint however, ignores Iran’s economic motives, just because the decision, if eventually taken, displeases the US does not mean that the rationale is purely political.

In light of such sentiments and the US’s current insistence that Iran be referred to the UN Security Council Iran must consider and weigh carefully the economic benefits against the potential political costs.

Although a matter of conjecture, some observers consider Iran’s threat to the petrodollar system so great that it could provoke a US military attack on Iran, most likely under the cover of a preemptive attack on its nuclear facilities, much like the cover of WMD America used against Iraq.

In November 2000, Iraq began selling its oil in euros, its Oil For Food account at the UN was also transferred into euros and later it converted its $10 billion UN held reserve fund into euros.

At the time of the switch many analysts were surprised and saw it as nothing more than a political statement, which in essence it may have been, but the euro has gained roughly 17% over the dollar between then and the 2003 US invasion of Iraq. Perhaps unsurprisingly, since the US led occupation of Iraq its oil sales are once again being invoiced in dollars.

The best policy choice for Iran would be to proceed with the IOB as planned as the economic advantages of such a bourse are clear, but in order to mitigate against the potentially greater political “threat” should provide customers with flexibility.

It would make it much harder for America to object to the new bourse, overtly or covertly, if Iran allows customers to decide for themselves which currency to use when purchasing oil, such an approach would facilitate for euro purchases without explicitly ruling out the dollar.

[As Aljazeera then put it: “Emilie Rutledge is a British economist who is currently based at the Gulf Research Center in Dubai”].

High time for a single GCC currency

First published in:
Al Jazeera

Rutledge, E. J. (2005, October 3). High time for a single GCC currency Al Jazeera. https://www.aljazeera.com/news/2005/10/3/high-time-for-a-single-gcc-currency

There has been a fair amount of scepticism towards the proposed Corporation Council for the Arab states of the Gulf single currency, not just in terms of the likelihood of it actually being launched but also with respect to the economic benefits it is expected to provide.

In terms of appropriateness, as all member states have similar economic structures – export-orientated economies – the single currency should be viable and not be that difficult to implement.

According to monetary theory, key benefits of currency union include the elimination of transaction costs and the generation of greater levels of trade between member states.

With regard to these theoretical benefits, reactionary economists argue that, as all six sovereign currencies are pegged to the US dollar, transaction costs are already effectively non-existent.

They also point out that a single currency would not stimulate much new intra-Gulf Cooperation Council trade as most of the region’s trade involves exporting oil and gas to Asia and Europe, not trading goods with one another.

For currency union to be effective, there will need to be a single independent central bank along with a GCC monetary authority.

Fiscal budgetry

These institutions would need to have the authority to set fiscal budgetary restrictions, and require member states to provide timely and transparent data including national accounts.

Many doubt, when push comes to shove, GCC leaders will actually defer to a supranational institution. A federation of existing central bankers would probably lead to a weak currency and increase the likelihood that it will stick with the dollar peg.

Much of the potential success or otherwise depends on two things: a strong independent central bank and what exchange rate mechanism the region’s policymakers decide to adopt post 2010.

It seems that at present there is little appetite – at least publicly expressed – to move away from the dollar peg, let alone consider invoicing future oil sales in Gulf dinars.

Reasons given for maintaining the status quo include the fact that the dollar is the de facto currency of international trade and that Opec oil sales are invoiced in dollars.

It is also a fact that GCC governments hold vast sums of dollar-denominated assets, such as US Treasury bonds. A move away from the dollar would see more uncertainty as to the value of these assets.

However, the dollar peg is not the optimal choice for the region’s economies.

As GCC economies mature and attempt to diversify away from dependence on hydrocarbons, the utility of the dollar peg needs to be critically examined.

Even if the current arrangement is kept as a convenient convergence tool up until 2010, once launched GCC leaders should seriously consider viable alternatives such as a managed free float or a loose peg to a trade-weighted basket of currencies.

Key problem

One key problem with the dollar peg is that it effectively means that GCC central banks have outsourced their decision-making powers on interest rates to Alan Greenspan of the US Federal Reserve.

Not having independent monetary policy tools can be problematic, particularly in terms of combating inflation and encouraging growth.

As a consequence decisions on whether or not to cut, hold or hike rates are based on economic conditions in the US and these are not always the most appropriate for the GCC.

It is often the case that the US economy will grow robustly when oil prices are low while GCC economies will either experience low levels of growth or stagnation.

Conversely when oil prices are high the pace of US growth eventually slows, and US interest rates have been low for several years now in an attempt to stave off recession.

These low interest rates which the GCC central banks have to track, are now exacerbating inflation in the GCC and leading to the overvaluation of some stock-market and real estate-assets.

There is also increasing concern over the size of America’s federal debt, which is almost $8 trillion. Its budget deficit this year alone is expected to be $600 billion. In recent years the US economy has been characterised by substantial budgetary deficits. It consistently spends more than it earns.

As a result, the US is becoming more and more dependant on foreign countries willing to hold dollars in their reserve accounts and buy its Treasury bonds.

Essentially the US Federal Reserve prints paper – Treasury bonds and dollar bills – and swaps these for commodities such as oil and consumer items such as Chinese household appliances.

The weakening dollar has also resulted in GCC imports from Europe becoming more expensive. When launched in 2002 a Saudi riyal was worth €0.29 euros; today it is worth only €0.21 euros.

This means that it has become 32% more expensive for GCC states to import goods from the eurozone, which happens to be the region’s largest import partner. Unlike the US, the eurozone does not run large trade deficits, and the European Central Bank imposes strict limits on government deficits.

If GCC states were to start shifting some of their dollar-denominated assets into euro-denominated ones prior to currency union, it would provide a good hedge against the expected downward decline in the dollar.

Even more significantly if, post-currency union, the GCC decided to allow the purchase of oil in euros along with the Gulf dinar and other currencies, they would see their euro assets appreciate massively, as a greater number of oil-importing nations would hold higher levels of euros in reserve and therefore increase its value.

Long-term value

Iran’s decision to open an oil and associated derivatives market in March 2006 is interesting, not least because it plans to invoice contracts in euros, not dollars.

It is not likely that many energy traders will leave New York or London and set up shop in Tehran, but Iran’s move does highlight a rising concern over the long-term value of the dollar.

If the dollar continues to decline against the euro, more states will increase the percentage of euros they hold in their reserves because the euro will be a better store of future wealth, and major oil suppliers will prefer to sell at least some of their oil for euros or currencies other than the dollar.

A strong, independent, single GCC currency is likely to attract increased levels of foreign direct investment to the region and facilitate the invoicing of some oil and gas sales in Gulf dinars.

Not only would this provide the region with substantially higher seigniorage revenues but it would also result in the Gulf dinar becoming, albeit a minor, reserve currency with a host of associated benefits, especially for the region’s non-oil financial sectors.

The currency could well be viewed by some Arab and Islamic states as a more “acceptable” reserve currency than that of the US dollar.

The notion that it would be too difficult to set up a market for invoicing oil sales in any currency other than the dollar is quite frankly ridiculous, and is largely being propagated by those with a vested interest in the current petrodollar hegemony.

[As Aljazeera then put it: “Emilie Rutledge is a British economist who is currently based at the Gulf Research Center in Dubai”].

Arabian Gulf Blog

ⁱ

This is the website of Dr Emilie J. Rutledge who, with almost two decades’ worth of experience in managing, designing and delivering economics courses at both undergraduate and postgraduate levels (Courses), is currently Head of the Economics department at The Open University.

erutledge.com

Dr Emilie J. Rutledge

Emilie has published over 20 peer-reviewed papers (Publications) and is the author of “Monetary Union in the Gulf”. Her current research focus is on employability, the feasibility of universal basic incomes and, the oil-rich Arabian Gulf’s economic diversification and labour market reform strategies. On an ad hoc basis, Emilie provides academic consultancy and specialises in developing interactive university courses, alongside analytical insight on the political-economy of the Arabian Gulf.
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