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Devaluation of GCC currencies or is it adjustment ?

According to the Qatar National Bank (brief of December 6th 2015), “For decades, five countries in the Gulf Cooperation Council (GCC) have kept their currencies pegged to the US dollar. Only Kuwait links its currency to a basket, but even this is believed to be heavily weighted towards the Dollar.

However, the recent sharp decline of oil prices has fuelled speculation in the currency forward markets about possible devaluation of GCC currencies.

These bets are likely to be misplaced for two reasons. First, the peg makes economic sense given the structure of GCC economies. Second, there is political will and ample resources in the GCC to maintain the peg.”

According to Kuwait-Mubasher: GCC countries’ currency peg to the US dollar is an “appropriate” policy as it provides stability for the inflation and growth rates, according to a report by the Qatar National Bank (QNB).

Five countries in the Gulf Cooperation Council (GCC) have kept their currencies pegged to the US dollar, while only Kuwait links its currency to a basket, but even this is believed to be heavily weighted towards the dollar.

On another front, the recent sharp drop in oil prices fuelled speculations in the currency forward markets about possible devaluation of GCC currencies.

These bets are likely to be misplaced for two reasons; the first of which is that the peg makes economic sense given the structure of GCC economies. In addition, there is political will and ample resources in the GCC to keep the peg, according to QNB.

If the GCC had been running a free-floating exchange rate regime, the decline in oil prices would have led to a depreciation of local currencies.

The report showed that the currency depreciation would have triggered a spike in inflation, given the large share of imported goods and services in the consumers’ basket.

International experience confirms this: consumer prices in Brazil and Russia are growing at a double-digit annual rate. In response, the GCC central banks would have increased interest rates to attract foreign capital, limit the depreciation of their currencies and control the rise in inflation.

Investment would have also declined due to the higher interest rates. And the increased volatility of inflation and exchange rate under the floating regime would have made it difficult to attract foreign labour and capital, which are key drivers of growth in some GCC countries.

As GCC exports become more diversified, currency depreciation could benefit non-hydrocarbon exports. But while the GCC has managed to diversify the sources of economic growth away from hydrocarbons, the diversification of exports is still lagging.

 

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