Weekly economic report

1. Page 1 of 2
Economic Commentary
QNB Economics
economics@qnb.com
6 December 2015
Assessing currency pegs in the GCC
For decades, five countries in the Gulf
Cooperation Council (GCC) have kept their
currencies pegged to the US dollar. Only
Kuwait links its currency to a basket, but even
this is believed to be heavily weighted towards
the dollar. However, the recent sharp decline
of oil prices has fuelled speculation in the
currency forward markets about possible
devaluation of GCC currencies. These bets are
likely to be misplaced for two reasons. First,
the peg makes economic sense given the
structure of GCC economies. Second, there is
political will and ample resources in the GCC to
maintain the peg.
To appreciate the virtues of the peg, it is
instructive to think about what would have
happened if the GCC had been running a free-
floating exchange rate regime. Under that
scenario, the decline in oil prices would have
led to a depreciation of local currencies. This
has happened to major oil exporters like Brazil
and Russia, whose currencies fell by 71% and
88% respectively against the US dollar since
mid-2014. Even other oil exporters who are
less reliant on oil such as Canada and Norway
experienced large depreciations of their
currencies (25% and 42% respectively over the
same period).
Currency depreciation would have triggered a
spike in inflation, given the large share of
imported goods and services in the consumers’
basket. International experience confirms this:
consumer prices in Brazil and Russia are
growing at a double-digit annual rate. In
response, the GCC central banks would have
increased interest rates to attract foreign
capital, limit the depreciation of their
currencies and control the rise in inflation.
As a result, growth would have almost surely
been negatively impacted. Private
consumption would have fallen as elevated
inflation would have reduced the purchasing
power of consumers and higher interest rates
would have made consumption less attractive
compared to saving. Investment would have
also declined due to the higher interest rates.
And the increased volatility of inflation and
exchange rate under the floating regime would
have made it difficult to attract foreign labour
and capital, which are key drivers of growth in
some GCC countries.
The thought experiment illustrates the
benefits of the current exchange rate regime.
But it has been argued that currency
depreciation could be helpful in boosting
export competitiveness and driving growth.
This is a valid argument for economies such as
Canada and Norway, but not applicable for the
GCC given that most of its exports are
hydrocarbons, whose prices are determined
internationally and are denominated in US
dollars. For example, a depreciation of a GCC
currency would not make its barrels of oil more
attractive than, say, Russian barrels of oil. Of
course, as GCC exports become more
diversified, currency depreciation could
benefit non-hydrocarbon exports. But while
the GCC has managed to diversify the sources
of economic growth away from hydrocarbons,
the diversification of exports is still lagging.
Given that the fixed exchange rate regime is
appropriate for the GCC, the next question is: is
it likely to be maintained? We believe the
answer is a clear yes for two reasons. First,
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

2. Page 2 of 2
Economic Commentary
QNB Economics
economics@qnb.com
6 December 2015
savings are in excess of 100% 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.
Cumulative current account surpluses
(2005-14; bn USD, % GDP)
Sources: International Monetary Fund and QNB Economics
In summary, the exchange rate peg to the US
dollar is an appropriate policy framework for
the GCC as it provides a stabilisation of
inflation and output growth. 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. But until then, there is
policy commitment and sufficient resources in
the GCC to maintain the exchange rate peg.
QNB Economics Team:
Ziad Daoud*
Acting Head of Economics
+974-4453-4642
Rory Fyfe
Senior Economist
+974-4453-4643
Ehsan Khoman
Economist
+974-4453-4423
Hamda Al-Thani
Economist
+974-4453-4642
Rim Mesraoua
Economist – Trainee
+974-4453-4642
* Corresponding author
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19
46
317
408
513
1,038
Bahrain
Oman
Qatar
UAE
Kuwait
Saudi
Arabia 139%
59%
151%
102%
297%
57%
% GDP