GCC dollar peg makes sense despite trade tensions: MUFG

At a time when escalating trade tensions globally are at the forefront of investors’ minds, concerns over the relevancy of the US dollar peg to the economies of the GCC region are misplaced, MUFG Bank noted in a recent report.

“Whilst downside risks to the global economic outlook are rising, with escalating trade tensions currently at the forefront of investors’ minds, we view that the direct impact on the GCC region from a prolonged global trade dispute, and ultimately the sustainability of the GCC currency pegs, as negligible,” the report added.

The exchange rate peg to the US dollar is an appropriate policy framework for the GCC region as it provides a stabilisation of inflation and output growth, said Ehsan Khoman, Head of MENA Research and Strategy MUFG.

As the GCC moves further down the diversification path, especially with regards to exports, it could benefit from a more flexible exchange rate regime in the future. However, until then, there is policy commitment and sufficient resources in the GCC region to maintain the exchange rate peg, the report added.

Noting that oil and gas remains the dominant export for the GCC region, Khoman added a devaluation would have limited impact on GCC export competitiveness which would quickly be eroded by the higher cost of imports and with it higher inflation.

“The currency peg in place in the GCC has indeed proven to be a successful nominal anchor, and even if the currency is devalued (adjusted) rather than abandoned, this would in our view only add uncertainty about future devaluations, and ultimately make the peg more vulnerable to further speculative attacks,” the report noted.

“Thus, from an economic policy perspective, it does not make intuitive sense in our view for the GCC authorities to choose to abandon the peg to the USD, or devalue (adjust) it.”

Given that the fixed exchange rate regime is appropriate for the GCC, the report cites two main reasons why the GCC pegged exchange rates will be maintained.

One, there is political will and commitment to maintain the peg given its economic benefits to consumers and the economy as a whole.

Second, there are ample financial resources to maintain the exchange rate peg.

“The GCC has accumulated large foreign-currency savings during the last oil boom that can be used to defend the peg. In many countries, these savings are in excess of 100 percent of GDP. And while some of these reserves have been used in recent months, they remain sizable and sufficient to defend the peg even if oil prices stay low for a few years,” the report noted.