Currency revaluation not the answer

NO SOLUTION: Currency reform alone is unlikely to bring relief for inflation-saddled Gulf states, according to one economist. (Getty Images)

Currency revaluation will not solve the Gulf’s soaring inflation problem, according to one economist, although a move away from a link to the US dollar will buy time for the region to adopt other policies to address the issue.

A report released by HSBC chief economist Simon Williams aims to address the topic of currency reform at a time when the monetary policy of the US Federal Reserve is forcing central banks in the Gulf to lower their rates, thereby fuelling record inflation here.

Despite region-wide price control measures such as subsidies and caps on rental properties, inflation continues to breach multi-decade highs.

In the HSBC report, cited by UAE daily, Emirates 24/7, Williams argues that, in opposition to what many analysts believe, a future revaluation is not likely before the end of the year.

“Despite the arguments in favour of change, policymakers are minded to maintain the status quo and the likelihood is the pegs will remain unchanged in 2008,” the paper reported Willams as saying.

“The costs that this will entail, however, are heavy,” he added.

Williams claimed that, although regional gross domestic product (GDP) has remained strong in recent years, currency ties to the flailing greenback have hampered the Gulf’s booming economies.

“Had they been allowed to float, the Gulf currencies would have strengthened substantially. Instead, they weakened 15 to 20% in nominal trade-weighted terms as they were drawn downward by the dollar,” he said.

But currency revaluation alone will not solve the inflation problem, according to Williams.

“The likely limited scope of near-term action would not solve the region’s inflationary problems,” he said, adding that efficient execution of any reform would “buy the region time, particularly if were coupled with fiscal reform.”

Soaring commodity prices have contributed largely to inflation across the Gulf, Williams argued, with domestic markets heavily reliant on imports to fuel growing demand for both industrial applications (such as construction) and core goods (such as food).

Gulf markets reacted violently to the Fed’s emergency 25-basis points cut in the discount rate on Sunday with all major indexes, with the exception of Kuwait, finishing lower at the day’s end.

The selloff continued on Monday as key indexes posted the largest one-day drops in months on fears the Fed will again take drastic measures to free-up liquidity in the capital markets when it meets again on Tuesday.

Most analysts expect the Fed to issue a rate cut somewhere in the vicinity of 50-75 basis points.

“The problem we have right now is not going to end soon,” Philippe Dauba-Pantanancce, senior economist at Standard Chartered Bank told ArabianBusiness.com on Monday.

“In the context of almost too much liquidity in the region, authorities should theoretically go in opposite direction [and cut rates],” he said.

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