Category: Bahrain

So the GCC central bank might come to Abu Dhabi. The statement has since been retracted, but it was a headline last week, and would be some sort of coup for the UAE.

September 23, 2006 | Gulf News | Andrew Shouler

https://gulfnews.com/business/sectors/banking/casting-off-from-the-dollar-1.256170

For many observers, however, the bigger story lay underneath in any case, in the apparent confirmation by Central Bank Governor Al Suwaidi that the US dollar will be abandoned in its role of currency peg, not by 2010, but by 2015.

If confirmed, it raises all sorts of questions, not just for the monetary regime and economies of the Gulf countries, but maybe for the dollar itself, hitherto pretty much unchallenged as the world’s unofficial reserve currency.

Central banks around the globe have stockpiled it in their reserves, and the Asian countries running huge trade surpluses have found themselves recycling those funds back whence they came, not only for investment opportunity but to help cover their own exposure.

The US has been able to run increasingly heavy deficits accordingly. Not even the triumphalist emergence of the euro took too much of a shine off the dollar’s pre-eminence. But if the creditor countries, in whole or in part ditched their traditional benchmark, this perpetual motion model might be under threat. It may be an unduly alarmist view, but it’s worth scouring around for some answers to the general proposition of a dollar implosion.

Some of the facts are plain and their implications unavoidable. US deficits imply dollar weakness for some time to come. “Some are suggesting that one of the reasons for current euro and sterling strength is that oil surpluses are [already] favouring those currencies,” Philip Khoury, Head of Research at EFG-Hermes, observes.

“Likely US slowdown driven by weaker consumption is likely to [bring it down further] due to lower interest rates.” The outlook seems no better. “Rising external indebtedness does not portend well for the dollar’s role.”

There are many who would agree with that prognosis. “We continue to be dollar bears over the medium-term”, says Steve Brice, Head of Regional Research at Standard Chartered. Even so, the idea of breaking easily from the dollar meets with little bullishness. The relationship has been in place for so long, there is a certain comfort zone involved. Jasim Ali, Head of the Economic Research Unit, University of Bahrain, believes “GCC states tend to avoid change and risks. I think the GCC states would most likely avoid other arrangements, despite some of the statements made.”

The picture may be muddier than that, however, insofar as the GCC states have differing levels of motivation. “States that are more diversified (like Oman, Bahrain and the UAE) have less of an incentive to keep the dollar peg,” opines Jane Kinninmont, economist at the Econ-omist Intelligence Unit. That’s an issue which may still delay monetary union anyway, she suggests.

There’s another reason to be cautious. “I’d be surprised if the single currency were to float,” Gulf analyst Robert Powell, also of EIU, remarks. “It would expose the single currency to the vagaries of the oil market, would create uncertainties for firms looking to invest in the GCC, and could also be a setback for those states’ efforts to diversify their economies.”
So the prospect of setting the GCC currencies free may be dimmer than supposed. But what if it did happen? Would that be serious?

Any such shift, particularly if oil were to be priced in different currencies, may exacerbate the dollar’s downtrend, Brice at Standard Chartered confirms. “To some degree this would be a fundamental issue, in both current account and capital account transactions from the region. However, it could also have a significant psychological impact, as a step towards a shift in hegemony.”
That said, there is no obvious replacement at this juncture, he continues. “Europe and Japan are still struggling economically, and the Chinese yuan is still a long way from being a reserve currency.”

Therefore, the US dollar is likely to remain kingpin for years to come, it would seem. Brice reiterates the importance of the US to the rest of the world. “As such, we expect any such reduction in reliance on the dollar to be gradual.”

Amid this conjecture, the bolder line is to say that the hour of the independent regional currency is fast approaching. “I feel it is about time the GCC states allow their common currency to float. This would enable them to really determine their competitive situation in the world market,” says local economist and entrepreneur Abdullah Sharafi.

Emilie Rutledge, visiting professor at the UAE University, goes further, anticipating the creation of a Gulf ‘dinar’ which might itself displace the dollar in central bank accounts. “From a geo-political context, the dinar may be perceived as more morally acceptable than holding the US dollar, and also a more Islamically-acceptable currency to hold either in reserve or indeed even to peg to.” That thought cannot be too far from the authorities’ minds, although it puts the regional order and international relations right into the melting pot.

Yet, while the system of the US swapping paper greenbacks for manufactures and commodities is losing viability, it will still be the decisions made by China which will carry far greater weight, Rutledge maintains. At the same time, a certain fatalism applies. Sharafi argues: “The USA is a superpower, behaves like a superpower, and is treated as a superpower. These monetary changes would not affect its position. The two are just not linked.” Whatever lies ahead, uncertainty prevails for now. Once the GCC countries have resolved the currency matter, clarity should ensue.

“It is important that the central bank’s intentions are flagged some time in advance, so businesses can protect themselves against the different currency and interest rate exposures they will face,” says Brice, ushering in the risk management story.

Risk indeed there is, but the dollar might itself sail serenely into its sunset. And, since the world is round, it might even return from the other side. Tomorrow is another day.
Andrew Jeffreys, Editor in Chief of Oxford Business Group, puts it as succinctly. “2015 is far off, and conditions may change,” he reminds. Hard to argue with that.

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.