Gulf currency revaluation ought to top the agenda in Doha today
Posted on 09 June 2008 with no comments from readers
GCC central banks are currently preoccupied with planning the scheduled monetary union in 2010. But if they are not more attentive to the inflationary boom in the region then by that date then they could have more pressing preoccupations such as dealing with an inflationary bust, and a return to the dark recessionary days of the early 1980s.
This was broadly the message that Standard Chartered Bank’s chief economist Dr Gerald Lyons brought to the Gulf on his tour last week, albeit he couched the conclusion in slightly less dramatic language. GCC Central Bank Governors sit down today in Doha to discuss the latest technical proposals on monetary union from their expert committee which engaged in a series of marathon talks in the Qatari capital last month.
Are the Central Banks spending too much time looking at the details of monetary union and even using it as a reason not to tackle more pressing issues at hand, such as the wholly inappropriate monetary policy now thrust upon the region courtesy of the dollar peg?
If anybody needs reminding the dollar peg means that Gulf central banks have lowered interest rates to two per cent at a time when the local money supply is growing at a phenomenal pace and oil prices have just hit $138 a barrel.
Loosening monetary policy in the face of a resource price boom is about the least appropriate policy that any group of central banks could impose. And Dr Lyons believes the situation is going to get worse with the US actually cutting interest rates again to one per cent early next year to counter an economic slump.
For the Gulf that will mean still cheaper money and fuel speculation in real estate still higher. Dr Lyons says that the GCC central banks really ought to learn from the recent lessons of the US sub-prime crisis where the availability of low-cost credit created a bubble in housing that has now crashed leaving the banks with huge write downs and home owners with negative equity.
Marios Maratheftis, regional head of research at Standard Chartered even suggests that currency reform could help to take some of the pressure off the US dollar if it was handled carefully. The US has, after all, been encouraging China to revalue its currency for years, and only last week Treasury Secretary Henry Paulson told Gulf journalists it was a ‘sovereign matter’.
As a former Senior FX Strategist with Standard Chartered Bank based in London, Maratheftis is an expert in currency issues. He points to Canada and Norway as good examples of oil producing countries that have used a floating exchange rate to dampen the impact of higher oil prices on domestic inflation. Both have similar oil exports as a percentage of GDP to the UAE but they have contained inflation at a low rate, albeit with currency appreciations of 60 per cent for Canada and 76 per cent for Norway.
Mr Maratheftis says that leaving revaluation or de-pegging until 2010 will be ‘just far too late’ because of the inflationary pressures building up in GCC economies which are set to post a current account surplus of $500 billion this year thanks to record oil exports.
The risk is that property prices surge to levels where the smallest shock can burst the bubble, although Standard Chartered is not expecting a correction in oil prices for one or two years or a housing correction in that period. What the bank does recommend are measures to absorb liquidity such as raising reserve requirements for the banks, something China did again last week and government bond issues to mop up liquidity.
And, of course, the bank recommends an immediate revaluation of Gulf currencies. Not to do so means that the current boom will turn to a bust ‘in the medium term’.
However, for the time being the central bankers meeting in Doha this week are focused on the technical detail of a 2010 currency union which UAE Central Bank Governor Sultan bin Nasser Al Suwaidi has already suggested is likely to be stage one or a partial monetary union by 2010.
On the agenda will be the bank’s organizational structure and convergence criteria for the union. Ironically enough, given that many economists argue that an immediate revaluation is needed to tackle soaring inflation levels in the GCC, the different levels of inflation among the nation states are seen as one hurdle that requires management.
Other criteria to be discussed are the ratio of debt to GDP, budget balances, unemployment and macroeconomic harmonization. Then there is the thorny issue of whether the new Gulf currency should be pegged to the dollar, or a basket of currencies or be free floating.
With the exception of Kuwait, Gulf currencies already have fixed rates of exchange between them due to the dollar peg. Therefore the technical side of monetary union should be far less complex than the flexible exchange bands of the old European Exchange Rate Mechanism that preceded the European Monetary Union.
What will likely emerge is a phased introduction of monetary union, with gradual movement of currencies to a basket band and crawl like the Singapore system, and a series of revaluations to dampen inflationary pressure in the run-up, preferably fairly large moves that would have a real impact on inflation.
My thinking is that the central banks will, after all, decide to heed the warnings of Dr. Lyons and his colleagues that revaluation is urgently needed, and that shortly they will declare it to be ‘in the national interest’ or find some other face-saving words.
