Gulf states set for currency showdown

Rulers of Gulf Arab oil producers are poised for a showdown over currency reform on Monday after the United Arab Emirates signalled it would press for an end to dollar pegs and Saudi Arabia quashed the idea.

Each side raised the stakes on Sunday. The UAE's state-run news agency said it expected rulers to change currency policy at a summit in Qatar, but retracted the report after ministers from other states said reform was not even on their agenda.

"We will not drop it. That's it," Saudi Finance Minister Ibrahim Al-Assaf told reporters in Qatar's capital Doha of the riyal's peg to the dollar.

Saudi Arabia, the largest Arab economy, has not changed the riyal's rate since 1986. With the Gulf's largest population, the kingdom ran budget deficits in the 1990s and fears a revaluation would cut the riyal value of dollar-denominated oil revenue.

Its smaller, wealthier neighbours are more concerned the tumbling dollar is stirring trouble among expatriates, who dominate their workforce, and hampering their central banks in the fight against inflation, at decade highs across the Gulf.

"There is a pro-reform camp and an anti-reform camp," said Marios Maratheftis, regional head of research at Standard Chartered bank.

"I believe a consensus will be found. If all hope had been gone, then the UAE would have moved already," he said.

After migrant construction workers rioted in Dubai over savings lost to the dollar's slide, the UAE central bank governor said last month he was under mounting social and economic pressure to drop its peg and track a currency basket.

UAE policymakers, from the finance minister to the head of the federal advisory body, then backed his call for currency reform, saying they would only act in concert with neighbours preparing for monetary union as early as 2010.

Expecting an imminent revaluation, UAE hotels started offering fewer dirhams per dollar from Saturday and forward rates showed investors betting on an appreciation of more than 3.5% in a year. The dirham hit a 17-year high last week.

So when UAE state news agency Wam said on Sunday currency reform would be on the agenda of the six-nation Gulf Cooperation Council summit and that rulers were likely to agree a shift this week, markets largely took the news in their stride.

"The link to the dollar was meant to unify cross-rates between the GCC currencies," Wam said, citing "official Gulf banking sources".

"The sources expected the leaders of the Council countries to decide at the Doha summit to change the tool linking the currencies," it said, without mentioning a currency basket.

Any move would be made together, it said.

"The comments indicate a move to a one-off revaluation by the same amount, or it could point to moving towards the same currency basket in unison," said Monica Malik, senior economist at Cairo-based EFG-Hermes investment bank.

Officials moved swiftly to dismiss the idea that the summit would tackle reform. Kuwait's and Qatar's finance ministers said it was not on the agenda of ministers preparing material for the rulers' talks. Wam retracted the story without an explanation.

A GCC official said the six states would have to consider reform if they meant to create a single currency after Kuwait broke ranks with its neighbours and started tracking a currency basket in May

"The GCC has two choices. The return of Kuwait to the dollar peg, or tying to a basket of currencies," said Raja Albqami, chairman of monetary union at the GCC secretariat.

GCC Secretary General Abdul-Rahman Al-Attiyah told Reuters earlier the finance ministers would discuss plans to speed up the single currency project, which has been in disarray since Oman opted last year not to join by 2010.

A source familiar with Saudi currency policy told Reuters last month Riyadh would not drop its peg but could be willing to consider a revaluation to keep plans for monetary union alive.

Kuwait blamed delays to monetary union for its decision to sever its peg, as well as rising inflation caused by the dollar's slide, which makes some imports more expensive.

Al Suweidi complained the pegs forced central banks to shadow US monetary policy to prevent currency appreciation; but while the Federal Reserve is cutting rates, inflation is running at a 19-year high of 9.3% in the UAE.

With more Fed cuts expected to contain the fallout from a mortgage crisis, and the dollar having just touched record lows against the euro, a Reuters poll showed markets believe reform is inevitable.

Most analysts expect the UAE to drop its peg first, possibly this year, and Saudi Arabia to follow, probably next year.