Regional dollar pegs to stay for now

Pressure to cut regional currencies free from their US dollar pegs is likely to remain subdued as the euro crisis and stable oil prices dissuade regional policymakers from developing independent currency regimes. GCC central banks are likely to opt to stick with fixed exchange rates as the dollar strength against the euro persists and oil prices remain below US$100 a barrel, say economists.

"The euro-zone crisis will persuade some policymakers they have been right to remain pegged to the dollar," said Simon Williams, HSBC's chief regional economist. "But my concern is that a strong currency is not what the region needs to grow its non-oil sector." Speculation emerged about a revaluation of regional currency pegs in 2007 as a sharp rise in the price of oil combined with a steep decline in the value of the dollar pressured GCC exchange rates. The inflow of capital rose steeply in anticipation of a currency review. Flows then reversed when it become clear currency regimes would remain.

"The trajectory of the dollar is different now to 2007," said Mark McFarland, an emerging markets economist at Emirates NBD. "There is a recognition ? now that any talk about the peg is counterproductive." Among GCC states, only Kuwait has dropped the dollar peg. The dollar's strength against the euro offers an advantage to Gulf importers as the cost of goods and services from the euro zone is lower.

But the exchange rate also poses a risk to the region's non-oil sector companies by making them less competitive globally. Hotel rooms and goods made in the region are more expensive to consumers in Europe. Under the fixed exchange rate, GCC central banks have to closely follow the monetary policies of the US Federal Reserve. A convergence on monetary policy with the US suits the GCC at the moment as governments look to keep interest rates low to spur economic recovery. As regional economies recover at a different pace to the US, the need to hone independent policy responses may become greater, said Mr Williams.

"I expect this region to grow more quickly than the US so the case for currency reform is still strong as interest rate control is needed," he said. @Email:[e-mail]