To Peg or Not to Peg

Qatar

Economic News

22 Jul 2010
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Qatar is being pressed from several different angles to drop its currency peg to the dollar. During the recent Gulf Cooperation Council (GCC) Leaders Summit in Doha, this was a hot topic of debate among global financiers.



There is no doubt financial leaders paid close attention to the proceedings of the summit for any hints about whether Qatar, along with other member states, would move towards getting rid of the peg to a currently weak US dollar, which has lost an estimated 24% of its value since the introduction of the euro.



High inflation, which rose by 12.8% year-on-year for the second quarter of 2007 and surged to 13.7% by the end of September, has led to a call for action from many in the business community. Coupled with the desire of some members of the Organisation of Petroleum Exporting Countries (OPEC) that oil should be priced in other currencies this has led to mounting pressure on the Qatar Central Bank (QCB) to consider its long-standing dollar peg. Qatar, along with many other GCC member states, is faced with negative real interest rates at a time of booming growth when positive ones are needed.



Asked whether GCC member states would de-peg their currencies on their own, Saudi Arabia's finance minister, Ibrahim Al Assaf told reporters, "We would do it as a bloc." However, conflicting information from many GCC leaders is fanning the flames of financier speculation from New York to Doha.



It is almost certain there will be no definitive statements regarding the subject in the near term, but global bankers and business leaders will be watching closely for any firm stances taken on de-pegging. Recent announcements from the United Arab Emirates (UAE) and Qatar had indicated their wish to abandon the dollar. However, statements made during the leaders' summit have leaned towards keeping the currency pegged until monetary union is achieved in 2010. Many have expressed hope the Qatari riyal (QR) will be pegged to a basket of currencies, such as Kuwait did in May, which has led to a 5% appreciation of the dinar.



The question has arisen for several countries, which have fixed their currencies to the dollar following the Bretton Woods II theory. This refers to the idea that newly industrialised countries peg their currencies to the dollar in an effort to increase exports. In return, they would be expected to invest their profits in the US, which acts as an anchor of last resort. As the value of the dollar has declined, Qatar and other GCC countries have had to hold large reserves of a devaluing currency.



Qatar remains in a catch-22 in that it cannot reduce interest rates at the same pace as the US Federal Reserve due to high local liquidity and inflation. This will lead to a widening differential between US and Qatari interest rates. The resulting options would be to restrain liquidity or, if inflation remains consistently high, to raise interest rates. The latter would further speculation about de-pegging the riyal.



During the summit, Sheikh Hamad bin Khalifa Al Thani, the emir of Qatar told reporters, "Right now, the policy is to stick to the dollar. [...] The GCC is concerned about the dollar. [There is] no decision on the currency for the moment." However, the Emir also said that any talks about de pegging the currency would have occurred in closed-door meetings, which only adds to further speculation.



Many analysts expect a system of cooperation will be introduced. Anais Faraj, executive director for the Middle East at Nomura Investment Banking, said a system of 'variable-geometry' could come up. This refers to the idea that all countries in the GCC do not have to take part in every policy but some can cooperate more closely than others. This would allow countries such as Qatar and the UAE to move ahead with plans to de-peg their currencies.



As Qatar continues to see a steady rise in inflation, there will be increasing pressure to de-peg the currency. The biggest question will remain on whether to keep the dollar peg and weather the current storm until monetary union or to make a move now to ease pressures until a monetary union is in place.

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