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INTERNATIONAL FINANCE
ASSIGNMENT II – GULF STATES’ CURRENCY PEG
Nowhere are the exchange rate policy dilemmas associated with recent
declines in the value of the US dollar more acute than in the Gulf States, where
virtually all the oil rich states have been pegging their currencies to the US
dollar. This assignment will address the current exchange rate policy options
for the States, and discuss if the link to the US dollar should be modified or
abandoned as some influential commentators have recently argued.
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Group 14 – Gulf States’ currency peg
INTRODUCTION ........................................................................
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4. POLICY RECOMMENDATIONS
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REFERENCES.............................................................................
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Group 14 – Gulf States’ currency peg
INTRODUCTION
Focus of this assignment is the current exchange rate policy of the Gulf
States. Particularly, we will assess the main arguments for pegging the
Gulf States currencies to the US dollar and will try to tackle these by
Since the collapse of the Bretton Woods system in the early 1970s, most
major exchange rates have not been officially pegged, but have been
allowed to float more or less freely for the longest period in recent
the world.
1
Sarno, L. and M. Taylor (2003), ‘The Economics of Exchange Rates’, pp. 177.
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six countries of the Arab Peninsula (Bahrain, Kuwait, Oman, Qatar, Saudi
Arabia and the United Arab Emirates). The GCC have taken number of
the dollar after 1973). This particular study concludes that real
nominal rate regimes. Thus, countries with pegged exchange rates will
experience lower volatility in the real exchange rate than countries with
Moreover, oil and gas exports are the major source of the vast wealth of
dollar-denominated, the dollar peg has served the GCC countries well as
it has proven stable in spite of huge volatility in oil prices. The dollar peg
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Group 14 – Gulf States’ currency peg
have been the main reasons for the GCC member states motivation for
Basically, this linking to the greenback was to provide an anchor for the
By 2006, the dollar peg, which has been applied for over two decades in
Middle East and Central Asia department at the IMF, with this anchor,
steady economic environment and low inflation have been the standard.
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would cut the local currency value of their foreign assets, which are
channelled from these countries into the global capital markets in the
period 2000-2006.
Kuwait 400
3
The Economist, Nov 22nd 2007
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Group 14 – Gulf States’ currency peg
Oman 10
Qatar 70
term plunge into current account deficit, as the local currency value of
Furthermore, if these countries alter the existing dollar peg, this might
also disturb GCC’s plans to trim down their reliance on oil export by
the region.
the dollar depreciate and the purchasing power of oil, whose price is
currencies.4
4
Financial Times, 22 Jan 2009
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Group 14 – Gulf States’ currency peg
reasons that undermine the current dollar peg. As a close ally of the US,
Saudi Arabia has so far tried to stick to the peg, but the link is now
difficult for these countries, which are all oil exporters, to adjust to
Spectacular boost in oil prices during the period of several years until
the summer 2008 (see the graph below5) has provided the Gulf
5
Source: www.thisismoney.co.uk
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Group 14 – Gulf States’ currency peg
On top of that, seeing that the dollar deteriorated a lot against the euro,
the cost of imports from the EU and other regions swelled substantially.
Inflation in the region rose to 4.5% in 2006, from an average 0.1% in the
kept on climbing, with each of the six members reaching record double
digit figures. Qatar is one of the countries to have been most affected
by the increase.
United Arab Emirates has been caused by rising import costs, which are
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Group 14 – Gulf States’ currency peg
and more shifting towards Europe and Asia, leaving the US with a lesser
below, for the GCC as a whole, the European Union is the most
that pegging the Gulf currencies to a pure Dollar peg could lead to the
Aside from the above piece of evidence that the EU provides a major
chunk of the imports for the Gulf States, the Euro has matured since its
dollar was taken at a time when the dollar was strong relative to all
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Group 14 – Gulf States’ currency peg
has lost over 50% of its value against the Euro since 2002:
Source: DataStream
would mean that the dollar could not guarantee its sole
dominance in future.”7
7
http://www.gulftimes.com/site/topics/article.asp?
cu_no=2&item_no=150715&version=1&
template_id=57&parent_id=56
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Group 14 – Gulf States’ currency peg
Except for the mentioned reasons to move away from a dollar peg,
there is also the pressure on the Gulf States to increase their non-oil
growth.
undiversified and reliant on the United States. However, they are now
as that would provide them with more space to counter economic and
financial shocks.
The current situation in the Gulf with weakening currencies due to rising
inflation and severely limited monetary policy due to the dollar pegs in
concert with interest rates following the decisions made by the Federal
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Group 14 – Gulf States’ currency peg
single currency.
would soothe some of inflationary pressure of the Gulf States but this
would not solve the main imbalance problem between exporters of oil
and a dollar peg. In fact, revaluing a currency does not add any value in
another option being considered for a long time. If the basket included
the strongest currencies around, for example the euro and the yen
along with a dollar, which still represents the biggest economy and
would have a big weight in any basket, could provide significantly more
rate policy. But this would not be the perfect result since these big
terms; though the idea of including more than the mentioned three
currencies would help with this, however the selection must be made
very meticulously.
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Group 14 – Gulf States’ currency peg
In the longer term though, the Gulf States should abandon the currency
non-oil sectors and exports (IMF 2002). Moreover, in the recent past
instead of using pegs. This means that the governments and central
banks were actually having inflation targets rather than aiming for an
exchange rate.
In the case the GCC countries finally decide to materialize their single
currency plans the new currency must certainly be floating, though not
POLICY RECOMMENDATIONS
In the mid to long run the outlook of a dollar is pessimistic. The recent
facts with the Federal Reserve printing and pumping the greenback into
the economy in order to fight the current crisis will certainly have its
side effects. Moreover, in the medium term this approach along with
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Group 14 – Gulf States’ currency peg
adequate to the nature of the crisis in terms of its length and depth will
The most likely and worst scenario in this case would be disappearance
of the current financial base (dollar and debt) all over the world and
There are already talks of new regional currencies, “Amero” for North
America (USA, Canada and Mexico) and Russian Ruble for Russia and its
closest allies. In this connection, the new single currency plans of Gulf
Now taking into consideration all of the above, we believe that in the
longer run the Gulf States should end their currencies’ peg to the dollar
8
Global Europe Anticipation Bulletin, GEAB #32
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Group 14 – Gulf States’ currency peg
the future the Gulf States should maybe consider selling their export
REFERENCES
• www.thisismoney.co.uk
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Group 14 – Gulf States’ currency peg
• http://www.gulftimes.com/site/topics/article.asp?
cu_no=2&item_no=150715&version=1&template_id=57&parent_i
d=56
• www.crealis.es
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