Arabian Gulf states likely to hold on to US dollar peg despite oil woes

The net current account surplus of the region stands at more than US$2 trillion, according to economists’ estimates. Athar Hussain / Reuters

Arabian Gulf nations whose currencies are pegged to the US dollar are unlikely to abandon them as oil hits 12-year lows, says a top ratings agency. They will instead focus on reducing spending, according to Standard & Poor’s.

At the same time, S&P said that the overall creditworthiness of Middle East sovereigns had deteriorated in the past six months as fiscal deficits rise and countries in the region burn through cash reserves as deposits from oil dwindle.

Still, nations including the UAE, Saudi Arabia, Qatar and Kuwait have enough money to see them through in the medium term and will probably accelerate efforts to diversify their oil-dependent economies, tap debt, reduce subsidies and boost revenues through taxes such as a value-added tax on goods and services. “All of those sovereigns are in very strong position, all of the Gulf Cooperation Council have sufficient funds to defend their pegs if necessary, so we expect GCC pegs to remain in place,” Trevor Cullinan, a Dubai-based primary credit analyst at S&P, said yesterday.

“They have served the GCC well in terms of managing inflation expectations and with regard to foreign currency inflows into the economy,” he added. “They are already going through substantial reform, such as subsidy reform.” The net current account surplus of the region stands at more than $2 trillion, according to economists’ estimates.

Mr Cullinan noted that Kuwait amended its peg to the dollar in 2007 when it switched from the US dollar to an undisclosed currency basket and that this model could be an option for the other GCC states pegged to the dollar – the UAE, Qatar, Saudi Arabia and Oman.

The UAE has defended its desire to keep the peg in place ever since the rout of oil began in earnest in the fourth quarter of 2014. Since mid-2015, the price of oil has shed more than 70 per cent of its value amid waning demand from fuel-hungry China and increased supply from North American producers.

Even though pegging the dirham to the US dollar yields many benefits, a major disadvantage is that the Central Bank is unable to have an independent monetary policy.

Although pegging their currencies to the dollar compels the UAE and other Arabian Gulf states to follow US monetary policy despite differences in economic fortunes, it has the benefit of tracking the world’s reserve currency.

And as the dollar strengthens against currencies such as the euro and the yen, imports from Europe and Japan become cheaper.

Some analysts and traders are not as upbeat on the ability of Saudi Arabia, the world’s biggest oil exporter, to defend its peg to the dollar. They speculate that Saudi Arabia may be forced to choose between cutting oil supply to bolster the price of crude or de-peg the overvalued Saudi riyal from the ever-strengthening US dollar that is depleting its forex reserves.

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