Dollar slide: is the Gulf ready to cut loose? No doubt about it, the dollar is in trouble and things look set to get worse before they get better. With oil prices standing at $90+ a barrel, the coffers of oil-producing states are bulging, but in real terms the scenario is giving rise to serious and widespread concern

Middle East, The, Dec, 2007 by Pamela Ann Smith

This reached a new crescendo at the end of October shortly after the Federal Reserve cut the rate to 4.5%, sparking the latest round of the dollar's fall. Financial authorities in Saudi Arabia, Bahrain, Qatar and the UAE quickly followed the Fed's actions by equal cuts of their own to maintain the peg with the dollar. Kuwait followed suit, although the emirate had made clear earlier this year that it wants to see a wider range of possible fluctuations between the dinar and the dollar, a move that was widely seen as a prelude to a possible complete float of the Kuwaiti currency. Their action was supported by some experts, including the IMF's Khan, who argues that the peg has been beneficial for the Gulf states and still is. "These countries don't believe that inflation is imported," he said, referring to the fact that the dollar's fall has raised the prices of goods and services bought from countries with strengthening currencies such as the euro, sterling and Australian dollar. "I think they are right ... 70% of their imports are priced in dollars ... They don't stand to gain very much from de-pegging their currencies."

"The hike in inflation and pricing is not due to imported inflation in Saudi Arabia," Sfakiankis said in October. "It is being domestically generated due to a lack of supplies in the local market. The rise in food prices has reflected pressure from the rising use of corn and other food items for bio-fuel production, bad weather in some countries, as well as an increase in demand for food as the world's population continues to grow."

However, other authoritative figures disagree. Riyad Bank's chief economist, Dr. Zahid Khan, for example, believes high oil prices, as well as the falling dollar, are having an adverse effect in Saudi Arabia. The increase in the kingdom's oil revenues had created a lot of liquidity in the local economy and too few goods, coupled with an increase in demand for those goods, a classic case of inflation. Imports from areas such as the euro zone, which supplies about 25% of the kingdom's goods, given the appreciation of the euro against the dollar, would cause a rise in inflation.

HSBC's King maintains that "in effect, Gulf policymakers have handed over monetary policy decisions to the Federal Reserve. That's absolutely fine," he said, "when the US and Gulf economic cycles are synchronised. However, with the US suffering from a sub-prime hangover which, in turn, is forcing interest rate cuts on the Federal Reserve, it's no longer obvious that the Gulf's economic interests are so readily satisfied by Ben Bernanke and his colleagues. Gulf inflation," King concluded, "is on the march."

The US investment bank, Morgan Stanley, was even more outspoken, in early November. The bank maintained: "In our view, fixed exchange rate regimes have never been good for GCC countries, and the fact that oil is priced in dollars does not justify dollar pegs. Today, with the dollar's weakness, these countries face an opportunity to adopt a flexible exchange rate system."