Saudi Arabia should drop the riyal's peg to the dollar and consider "alternative exchange rate regimes" if inflation persists and the Gulf single currency is delayed, the International Monetary Fund (IMF) said yesterday. For the moment, most IMF directors believe the advantages of the peg outweigh its disadvantages, the fund said in a report published on its website. Still, some recommended reviewing the peg immediately.
Inflation in Saudi Arabia accelerated to above 10 per cent in April, echoing a regional trend in which inflation has soared. Inflation stands in the double digits in all GCC countries, aside from Bahrain. In the UAE, the most recent official figures put inflation at 11.1 per cent for 2007. Inflation has emerged as the Gulf's number one economic challenge in recent months. If costs rise too rapidly, it could dampen ambitious expansion plans that countries have embarked upon in the wake of high prices for their oil exports.
A revaluation of currencies, or abandoning dollar pegs altogether, have been touted in some corners as a partial solution to the inflation problem. Yet government officials across the GCC have reaffirmed their commitments to the peg ahead of a planned monetary union, which was originally scheduled for 2010. Saudi officials have repeatedly denied that their government plans to drop the riyal's peg to the dollar, insisting that the pick-up in inflation is largely caused by domestic factors, such as a housing shortage. In the UAE, too, rising housing costs and inflation in global food prices have been inflation's main drivers.
"Directors observed that the peg of the riyal to the US dollar has provided a credible anchor that has contributed to macroeconomic stability," the IMF said. "If, however, inflation should persist and the Gulf Co-operation Council monetary union be delayed, they recommended to consider also alternative exchange rate regimes." Kuwait, the only one of the six GCC states to have dropped its currency's peg to the dollar, said inflation accelerated to a record 11.4 per cent in April, before slowing to 11.1 per cent in May. While that may appear to show that abandoning dollar pegs does not combat inflation, Kuwait's new peg is to a basket of currencies, and that basket is thought to be heavily weighted to the dollar.
The 2010 deadline for the creation of a regional currency was thrown into doubt after Oman pulled out last year and Kuwait dropped the peg. Most analysts now believe the union will not happen until after 2012, as the location and function of institutions such as a central bank are still to be decided. A draft of the Monetary Union Agreement, which provides a legal framework for the currency, will be considered by finance ministers in Jeddah next month.
Inflation is the "main challenge" to the Saudi authorities in the coming period, the IMF said, advising the government to control spending. "In view of the limitations imposed on interest rate policy by the currency peg, fiscal restraint will be critical," it added. @Email:afitch@thenational.ae * With Bloomberg
