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HomeBanking & FinancePegs are not going away anytime soon

Pegs are not going away anytime soon

|By Arabian Post Staff| While market speculation about a possible de-pegging or devaluation of the dollar by GCC countries is going forward, a number of disincentives to such a move are continuing to force a status quo, at least in the short to medium term.

Analysts note that a more flexible foreign exchange regime could allow the GCC to adjust to real shocks better, the gains in terms of room for conduct of independent monetary policy are curbed by existing institutional arrangements, underdeveloped instruments, as well as limited interest rate policy transmission mechanism.

For instance, the latest report by Bank of America-Merrill Lynch on the issue points out how devaluation gains appear overstated, given low exchange elasticity of external and fiscal accounts. According to the report, if reforms were to happen in the foreseeable future, out of the three pillars of the regional macro view (namely, fiscal, energy and exchange policy), the ones that are most likely to undergo reforms would be the first two .

The USD peg has served the GCC well for decades by providing a nominal anchor to the economy and expectations.  In this respect, the GCC pegs have permitted to the region to run broadly low inflation, to simplify trade and financial transactions, and to reduce uncertainty as to the domestic value of oil export receipts.

A devaluation would improve the fiscal and external accounts, but the impact is likely overstated given the need for a large exchange adjustment, the loss of a credible nominal anchor to the economy, the need to compensate public workers for higher cost of living and the existing high import needs for the economy.

A devaluation would need to be very large to make a dent to the twin deficits, according to the report. This provides a disincentive to conservative policy-makers as a rebound in oil prices instead makes the fiscal adjustment effortless.

While all GCC countries have expressed their commitment to the USD pegs, BoA-ML believes that  theability to defend the arrangements in a sustained oil price slump varies greatly. Within the GCC, Kuwait, Qatar and the UAE are still in a comfortable position given fiscal breakeven oil prices of US$50-65/bbl and fiscal buffers that can cover deficits.