Business & FinanCe

gCC CurrenCies & The euro

While the currencies of the Gulf Co-operation Council (GCC) countries have depreciated alongside the dollar, the depreciation is even worse in the case of the euro, making many of the Gulf’s imports more expensive. Some feel that this “imported inflation” is a major cause of the huge price rises being seen throughout the region. But most GCC officials have rejected this view and announced their intention to stick with the peg to the US dollar, a policy that does little to curb inflation. By pamela ann smith

The demand for change is mounting. Linking the riyal, dinar and dirham to a basket of currencies, rather than the dollar, would help ease rising prices, experts argue, while others, including many Gulf officials, say that what is really needed is a currency union in the GCC, a common market and floating exchange rates – for oil as well as GCC currencies. A scheduled “emergency” meeting of GCC central bank governors early this month should shed some light on the choices, and policies, ahead. Figures produced by The Middle East and the Riyadh-based investment bank, NCB Capital, show that GCC imports from the euro area averaged about 21% of the total in 2006, almost double the 10% supplied by the United States. Leaving out Bahrain and Oman, which source more of their imports from the neighbouring Gulf states, the figures are 25% and 12%, respectively. Europe is now the Gulf’s most important supplier, well ahead of many of the Asian countries such as China, Japan, Korea and India, as well as the US. Exports to all six states, including Saudi Arabia, Bahrain, Kuwait, Qatar, Oman and the UAE, by the 27-member European Un

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ion (EU) are worth almost $100bn a year, according to the latest figures from Brussels, making the GCC the EU’s fifth most important market. In particular, the GCC relies on Europe for much of its machinery and equipment, petrochemical and power generation plant, appliances, aircraft, railway locomotives and cars, as well as the skills of its expatriate professionals and financial and technical services. This makes any significant appreciation of the euro against local currencies doubly worrying, especially given that oil, the region’s most important source of revenue by far, is still priced in US dollars. Since 2002, the greenback has declined by 78% against the euro, according to NCB Capital research. In addition to the rising demand for European goods and services at home, Gulf nationals and foreign expatriates are also seeking to take more of their holidays in Europe, central bank of ficials have noted, particularly since the increased visa restrictions on GCC citizens and other foreigners visiting the US since 11 September, 2001. Given that the euro is increasingly being seen as an alternative “reserve” currency alongside the US dollar, Gulf officials are also concerned about the effect a continued

euro appreciation against their currencies will have on their efforts to boost the euro’s share in their own reserves. Equally important, they and the Gulf banking community have noted, is the additional expense that could be incurred for public and private investments in the eurozone. Many of the GCC’s sovereign wealth funds (SWFs), which are reaping massive surpluses due to the record high oil price, have been looking to place their surplus earnings in the EU, a trend that could accelerate following the expected signing of a free trade agreement between the two regions later this year. The UK, which lies outside the eurozone, and whose pound sterling has depreciated by about 17% against the euro since February, has already been a major beneficiary of the SWFs’ attempt to diversify their holdings out of the US and out of dollar-denominated instruments, analysts in London report. “Our belief is that the UAE dirham is substantially undervalued, and it’s not good for the economy to have it where it is,” observes Shayne Nelson, Standard Chartered Bank’s chief executive for the Middle East and North Africa. “You’ve got negative real interest rates, which always leads to asset inflation,” he added, confirming growing concern in the GCC that the region’s double-digit inflation could be creating a bubble in local housing and real estate – sectors that play a huge role in the Gulf’s burgeoning prosperity – and even in local and regional stock markets despite recent corrections. Overall, inflation continues to accelerate across the world’s biggest energy-exporting region, according to official figures published in April. It has touched a 27-year peak of 8.7% in Saudi Arabia, an 18-year high of 11.1% in Oman and almost a new record, at 13.7%, in Qatar. Unof ficial estimates put the figures much higher. Rents, food prices, gold jewellery and many consumer goods are particularly affected, aggravating the declining purchasing power despite government increases in

The GCC relies on europe for much of its machinery and equipment, petrochemical and power generation plant, as well as the skills of its expatriate professionals and financial and technical services

1.Nominal US$ Depreciation (%)

sources: nCBC research, iMF, iFs, *nominal effective exchange rate depreciation (neer), ** real effective exchange rate depreciation (i.e. allowing for inflation) (reer)

wages and subsidies. Foreign workers in the private sector, whose numbers are huge and growing, have been hit not only by rising prices but by the lower value of the money they send home. Prospects of a currency realignment can only grow, according to other experts, if the US continues to cut interest rates aggressively, thereby weakening the dollar further. “You don’t have the monetary policy or the exchange rate to combat inflation, so you are left just with fiscal policy, which is expansionary right now,” Mohsin Khan, director of the Middle East and central Asia department at the International Monetary Fund said. “This is a dilemma.” Surges in the price of crude oil and fuel as a result of the weakening dollar as well as supply and demand volatility have also supported the euro, according to investment bankers in London, who say the trend could continue. “The euro is certainly gaining stature in the region as it offers a more stable reserve option to the falling dollar,” maintains Tristan Cooper, a Dubai-based sovereign risk analyst for the ratings agency, Moody’s. Kuwait has already de-pegged from the euro, and the likelihood is increasing, he adds, that some or all of the other five GCC countries which currently align their currencies to the dollar will also adopt a wider basket of currencies. “Given that around a

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