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Abu Dhabi, UAEWednesday 19 December 2018

GCC currency pegs remain resilient, can withstand future pressures

Regional governments have considerable reserves to ride out market volatility

Market speculation that some countries may adjust long-standing currency peg against the US dollar have not panned out Reuters / Fahad Shadeed
Market speculation that some countries may adjust long-standing currency peg against the US dollar have not panned out Reuters / Fahad Shadeed

Currency pegs in the GCC’s hydrocarbon-dependent economies remain resilient despite a three-year oil slump and considerable reserves held by Gulf States will help them withstand any pressures in the future.

The six member states of the Gulf economic bloc will however have to continue diversifying their economies, execute fiscal reform agendas and generate additional revenue streams to fend-off threats to their currencies' ties to the US dollar in future, Indosuez Wealth Management, the global wealth management arm of France’s Credit Agricole Group said.

Countries in the region, which account for about a third of the world’s proven oil reserves, heavily rely on sale of crude for income. The price of oil has slumped more than 50 per cent since the mid-214 peak of $115 per barrel and has hovered around $50 level for the past few weeks. The diminished oil revenues have dented the financial muscle of the Gulf States who are now running their separate fiscal and economic reform programmes.

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Crude fell below $30 per barrel in the first quarter of 2016 and the market speculated that it could slide below $20 a barrel, which stoked speculation that some of the GCC countries could abandon their currency peg. However, that talk has since dissipated as regional governments put austerity measures in place, cut spending on multi-billion infrastructure projects and raised funds through international debt market to bridge fiscal gaps.

Foreign currency reserves, amassed in the past, have given GCC governments, and the broader MENA region, a cushion to withstand pressure on their economies and the currency pegs. Saudi Arabia, Opec’s top oil producers and the region’s biggest economy, alone holds about $500b in reserves out of MENA region's total of $875b.

“Saudi Arabia is able to rely on its reserves that remain considerable and amount to more than two years’ worth of imports. This should allow the authorities to withstand any pressure on the peg, but should not pause any diversification efforts and various reforms that the country has been active with,” Paul Wetterwald, the chief economist at Indosuez Wealth Management said in a research note. “This is because the country’s currency is historically pegged to the dollar and cannot afford to persistently run current account deficits.”

The kingdom’s current account went from a surplus to a deficit of 8.3 per cent in 2015 and more recently the country managed to avoid a “twin deficit” in the first-quarter of this year. Reserves, although still substantial, continued to decline over the January-May 2017 period and stand now at $499b , -- a decrease of $247b since its August 2014-high, according to Indosuez.

Elsewhere in the GCC, Bahrain’s surplus shrunk to 3.4 per cent of its GDP in 2014 and Kuwait’s fell to 7.5 per cent in 2015. Oman’s debt was cut last year to below investment-grade by all three of the major credit ratings agencies.

Going forward, there could be additional pressures that could influence the global economic scenario and the health of economies in the region: mainly the uncertainties associated with the current US administration.

“The key issues for MENA economies are the strengthening of the US dollar, the possible rarefaction of the currency outside the United States following the repatriation of war chests by US businesses and the rise in interest rates,” Dr Wetterwald said. “These developments would negatively impact the debt refinancing of some countries lacking natural access to the dollar through regular export flows.”

Currency pegs are tested by a forward exchange market for contracts that set the future delivery of a currency at a specified exchange rate. In June forward contracts for the Omani rial, which is pegged at a rate of 0.39 rial to the dollar, jumped to a five-month high, according to prices compiled by Bloomberg.

Forward contracts for the rial that expire in 12 months climbed to 850 points on June 28, according to data compiled by Bloomberg. They stayed at that level for most of July before easing to 800 mid-month. The contracts are about 70 per cent higher than those for Qatar, which has been engulfed in a political crisis with four Arab countries since for almost three months. In June, Qatar’s riyal which is also pegged to the greenback, traded outside the country’s central bank’s range weakening it by 3.6 per cent, according to Bloomberg.