DOHA: The continuing large terms-of-trade shock has increased market speculation that the GCC’s US dollar pegs could break going forward. Key to the view is a combination of still sizeable foreign assets in parts of the GCC and the apparent start of a regional multi-year fiscal adjustment process.
There are three aspects to consider when evaluating the future path of forex (Fx) policy in the GCC: willingness, desirability, and ability to maintain the USD pegs. All GCC countries share a willingness and commitment to maintain unchanged Fx policies, Bank of America Merril Lynch (BofAML) noted in its latest ‘global market report’.
The USD peg has served the GCC well for decades by providing a nominal anchor to the economy and expectations, in our view. The literature suggests the optimal choice of an exchange rate regime should yield external and internal stability, preserve monetary credibility and competitiveness, and reduce balance sheet risks and transaction costs.
According to BoFAML analysts, the GCC pegs have permitted to the region to run broadly low inflation, to simplify trade and financial transactions, and to reduce uncertainty as to the domestic value of oil export receipts. The relatively low export diversification, apart from the UAE, suggests non-oil sector competitiveness matters in a stronger dollar environment are secondary in the short term.
External stability is harder to assess as large current account surpluses during the oil boom partly reflect necessary intergenerational savings given finite oil resources. External deficits are thus the mirror image of this in the current situation. Exchange rates are likely currently misaligned but the equilibrium REER (real equilibrium exchange rate) likely also depends on the medium-term level of oil prices which could rebound going forward.
On Saudi Arabia, the BofAML said it does not expect the Saudi-Iran diplomatic crisis to lead to major supply disruptions. However, this may exacerbate an Opec market share competition in the face of forthcoming Iranian oil supplies, and push oil prices lower. In turn, this could increase pressure on GCC pegs.
“We reiterate our view that the core GCC USD pegs, including that of Saudi Arabia, are likely to hold at current oil prices. Oman is the most vulnerable, in our view,” it said.
The implicit conservative oil price assumption in the 2016 budget further suggests that Saudi Arabia is unlikely to capitulate on its energy policy as the adjustment is being carried on the fiscal front. BofAML believes budgeted revenue numbers would be consistent with an internally budgeted oil price assumption of $40-45 on its estimates. With oil prices moving lower from these levels in December, Saudi Arabia instead chose to proceed with energy, electricity and water administered price adjustments as these were announced concurrently with the budget, but not included in the budget announcement itself.