Dollar's decline hasn't shaken Arab central bankers yet

By Matthew Brown
Bloomberg News Service
Monday, March 31, 2008

http://www.bloomberg.com/apps/news?pid=20601109&sid=auiN1nCBZano&refer=home

DUBAI -- Central bankers in the Middle East are proving that the U.S. dollar's decline to record lows is a small price to pay for the loyalty -- and oil money -- of their biggest Western ally.

The governor of the Saudi Arabian Monetary Authority, Hamad Saud al-Sayari, called the dollar a "good buy" when it fell to $1.55 a euro on March 12. The United Arab Emirates, conceding to U.S. pressure, will keep the dirham tied to the currency, a UAE central bank official speaking on condition of anonymity said March 17.

While a booming economy has pushed the average rate of inflation to above 7 percent in Saudi Arabia and the five other Gulf Cooperation Council members, none say they will follow Kuwait and resolve the problem by ending their fixed exchange rates to the dollar. That's because doing so may spark a new dollar crisis, said Simon Williams, the chief Gulf economist at HSBC Holdings Plc in Dubai, a move that would slash the value of their $500 billion of assets denominated in the currency.

"The Gulf states may be decoupled from the U.S. economy, but they are still shackled to the dollar," Williams said. "While they recognize the shortcomings of the status quo, policy makers seem minded to maintain it, at least for now."

The survival of the pegs shows how hard it is for major economies to break from the dollar, regardless of its 13.4 percent decline on a trade-weighted basis in the past 12 months. Saudi Arabia keeps the riyal fixed at 3.75 to the dollar by purchasing or selling the greenback with the local currency.

Gulf central bank governors will hold the first of two meetings this year in Doha, Qatar, on April 6-7 to discuss monetary and currency policy.

Speculation about a revaluation peaked in November before a GCC meeting. UAE central bank Governor Sultan Bin Nasser al-Suwaidi said he might link the dirham to a basket of currencies, and an unidentified official from the Saudi Arabian Monetary Authority said a revaluation was under consideration. The UAE dirham and the Saudi riyal both jumped to 20-year highs.

GCC countries are unwilling to change because so much of their revenue comes from oil, which is priced in the U.S. currency. Saudi Arabia, the United Arab Emirates, Kuwait, Qatar, Oman, and Bahrain control 40 percent of the world's proven crude reserves. Oman earned about 65 percent of its revenue from oil in the past year, government data show. Half of Saudi Arabia's gross domestic product is accounted for by the oil and gas industries.

Saudi officials rejected a suggestion by Iran and Venezuela to stop pricing crude in dollars at a meeting of the Organization of Petroleum Exporting Countries in Riyadh on Nov. 19. Saudi Arabia doesn't want the U.S. currency to "collapse," Foreign Minister Prince Saud Al-Faisal said.

"If OPEC made a definitive statement that it was going to be paid in other currencies, you could get a run on the dollar," said John Waterlow, an analyst at Edinburgh-based energy advisers Wood Mackenzie Ltd. "But they are so heavily invested in dollar-denominated assets it would damage their financial position."

GCC states' accumulation of dollar-denominated assets increased in 2007, even as the U.S. currency lost 10 percent against the euro. Dollars accounted for 67 percent of new GCC state assets managed by their central banks and sovereign wealth funds in 2007, up from 60 percent in 2006, according to RGE Monitor, a New York-based economic consulting firm led by former White House adviser Nouriel Roubini.

Linking their currencies to the dollar forces the GCC states to lower their interest rates in lockstep with the Federal Reserve. That reduces their ability to fight inflation, which accelerated to between 7 percent and 10 percent by the end of 2007, from an average annual pace of 1.4 percent in the decade through 2005, according to Commerzbank AG.

Rising prices, in turn, diminish the competitiveness of Gulf states as they seek to attract foreign employees. About 90 percent of the workforce in the UAE and Qatar comes from overseas, according to the U.S. Department of State. Almost half of all companies in the GCC say revaluing their currencies would be positive for business, a survey by HSBC showed in January.

"Price stability is paramount when it comes to ensuring longer-term growth and making the region an attractive destination," said Marios Maratheftis, head of research for the Middle East and Pakistan at Standard Chartered Plc in Dubai.

The GCC states are diversifying their reserves. The U.A.E began buying euros in 2006 to increase the share of the European currency in its reserves to 10 percent from 2 percent.

The Qatar Investment Authority, the emirate's sovereign wealth fund, holds about 40 percent each in dollars and euros, according to RGE Monitor. The fund is looking at investment opportunities in countries including China, Japan, Korea. and Vietnam to diversify currency risk, Kenneth Shen, head of strategic and private equity at the QIA, said in September.

Political pressure keeps Gulf states wedded to the dollar. Al-Suwaidi received calls from U.S. government officials after saying in November he might drop the peg, a person familiar with the matter said Jan. 3 on condition of anonymity. He received more calls this month after Dow Jones Newswires reported that the central bank had started a study into linking the dirham to a currency basket, a central bank official said.

"The U.S. has always been the guarantor of the Arabian Gulf's military security," said Anoushka Marashlian, senior Middle East analyst at Global Insight in London. "Gulf policy makers wouldn't do anything to compromise that relationship, especially considering current tensions surrounding Iran."

Before adopting the pegs, five of the GCC states used the Gulf rupee issued by the Reserve Bank of India and linked to the British pound. The UAE began pegging the dirham to the dollar in 1978, while Saudi Arabia began tying the riyal to the U.S. currency in 1986. Kuwait pegged the dinar to a basket of currencies from 1975 to 2003 before using the dollar in preparation for a single Gulf currency. It abandoned that system in May.

"Analysts from outside the Gulf tend to look just at the economics," said HSBC's Williams. "They see that depegging from the dollar makes sense and assume that change is imminent. What they sometimes miss is the politics of regional decision making. They underestimate the magnitude of the decision."

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