Intimidated by Inflation, Gulf States Consider Cutting Ties with Dollar

By Jason Simpkins
Associate Editor

Even with a bit of a rebound, of late, the dollar is down more than 7% against the euro in the past six months, 12% in the past 12 months and nearly 28% in the last 54 months.

The decline has been so drastic countries that have pegged their currencies to the beleaguered greenback are beginning to consider alternatives.

But Gulf States, particularly, have been torched by the dollar's decline. About 18% of inflation in the United Arab Emirates is caused by the Gulf state's currency peg to the dollar, Emirates Business 24/7 reported, citing the Dubai Chamber of Commerce & Industry's senior economist. The U.A.E.'s inflation rate is about 12%, the report said.

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Inflation has risen to 10% in Saudi Arabia and Qatar's consumer prices rose 14% in the fourth-quarter, Bloomberg News reported.

In an interview with Bloomberg, Kuwaiti Finance Minister Mustafa al-Shimali acknowledged that several Gulf States are considering abandoning the peg even though the United Arab Emirates and Qatar have ruled out such action. 

"Yes, there are some" Gulf Cooperation Council states considering dropping their pegs to the dollar, al-Shimali said. "Some countries will do what we are doing."

Kuwait dropped its peg to the dollar a year ago. Since then, the Kuwaiti dinar has appreciated nearly 8% against the dollar.

Last month, a panel of experts was convened in the U.A.E. to assess the nation's peg to the tumbling dollar. Ultimately, the panel recommended keeping the fixed exchange rate, but a committee was established to further probe the possibility of a currency revaluation.

In spite of soaring inflation, several Gulf States were forced to cut interest rates to keep in line with the U.S. Federal Reserve, which slashed the federal funds rate to 2.0% yesterday (Thursday). Dollar pegs in the region compel these states to track the Fed and maintain the relative value of their currencies.

Yesterday, Qatar and Bahrain cut their deposit facility and one-week deposit rates to 2% respectively. The U.A.E. central bank reduced its overnight repurchase rate, the rate at which the central bank lends to other banks, to 2% from 2.5%.

"Gulf states are taking the steps they can to dampen the impact of the inappropriate monetary stance that the dollar peg is forcing them into," Simon Williams, regional economist at HSBC Holdings PLC (HBC), told Reuters. "The goal is to moderate liquidity growth without triggering flows onto the currency."

Last month, speculation that the Gulf States would begin distancing themselves from the dollar provoked a rush of investment into their respective currencies. They would like to avoid that kind of speculative distortion in their exchange rates moving forward.

News and Related Story Links:

• Bloomberg:
  Gulf States May End Dollar Pegs, Kuwait Minister Says

• Gulf Daily News:
  DINAR-dollar peg 'will help Bahrain'

• Reuters:
  Gulf cuts some key rates as Qatar signals tightening