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All eyes on GCC for signs of currency policy rift

Gulf Arab oil producers risk renewing market bets on the demise of their dollar-pegged exchange rates if they give the slightest hint of a rift on currency policy at a weekend meeting on regional monetary union.

The official purpose of the meeting in the Saudi city of Jeddah - to review the timetable for a single currency in the world's biggest oil exporting region - holds relatively little interest.
Saudi Arabia and the five neighbours agree the 2010 deadline will be difficult, if not impossible, to meet.

Kuwait has already reneged on a pledge made with the other five to keep its currency pegged to the tumbling dollar to prepare for monetary union. Divisions among the other five over inflation targeting at the last meeting of policymakers fired intense market speculation that they would follow.

With the dollar at record lows, regional inflation at decade highs and central banks facing the prospect of tracking more US interest rate cuts, the central bank governors and finance ministers will be hard pressed to maintain a united front at the meeting on Saturday and Sunday, analysts said.

"Divergence is already occurring in fighting inflation and interest rate policies," said Koceilas Maames, African and Middle East Economist at Calyon Bank in London.

"I believe this divergence will continue with forex policy and we will be watching for signals of change in the exchange rate regime," he said.

The monetary union deadline began slipping when Oman opted last year not to join by 2010.

2015?

Kuwait blamed the delay for a decision to break ranks with its neighbours and adopt a basket of currencies in May.

A single currency is unlikely even by 2015, UAE central bank governor said in remarks published this month. Central bankers of Qatar, Bahrain and Saudi Arabia have repeatedly said the deadline would be difficult to meet.

"A statement announcing delay... would be read as evidence that the Gulf states are preparing to adopt more independent responses to the increasingly acute challenges they are facing," HSBC Middle East economist Simon Williams said in Dubai.

"Rising inflation, dollar weakness, low US rates are having a direct impact on the real economy and the market will be watching the meeting for signs of their response," he said.

Apart from Kuwait, the Gulf states agree that allowing their currencies to appreciate against US is not an option for now. At the last meeting of central bank governors in Saudi Arabia last month, they could agree about little else.

The six said they would fashion separate responses to any US interest rate cut.

When the Federal Reserve cut rates on September 18, Saudi Arabia, Oman and Bahrain declined to follow, choosing to ride out pressure on their currencies rather than stoke inflation at home. The Saudi riyal hit a 21-year high on the news. Qatar and UAE, the two countries with the region's highest inflation rates, cut some key rates along with Kuwait, to help deter bets on currency appreciation.

With the U.S. economy faltering after the mortgage-market meltdown, the 50-basis point cut on Sept.18 is unlikely to be a one-off test of the Gulf's commitment to dollar-pegged exchange rates.

Economists polled by Reuters this month expect the Fed to cut another 50 basis points by the end of the first quarter including a 25-basis-point cut this year.

"As cuts continue something will have to give," said Marios Maratheftis, regional head of research at Standard Chartered Bank.

The UAE and Qatar were tipped as the countries most likely to revalue their currencies in a Reuters poll last month.

Central bankers of both countries have repeatedly ruled out a unilateral revaluation as have the Saudis, Bahrainis and Omanis. Any change in that rhetoric would put more pressure on the currencies.

"I think there are discussions on doing this multilaterally," Maratheftis said.

"Long term it does make more sense to have a peg to a basket of currencies rather than the dollar." - Reuters

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