Riyadh has kept the riyal pegged to the dollar as the US currency fell over the past two years, pushing Saudi inflation to a 30-year high. Now the dollar is recovering, it has one reason less to change.
“I don’t see anything in the IMF report that says we are wrong,” said a senior Saudi government official familiar with policymakers’ thinking.
“We have seen the worst of the inflation without having to revalue our currencies, so there is economic sense in keeping the dollar peg for the moment,” the official, who asked not to be named, told Reuters.
In a carefully-worded report this week, the International Monetary Fund said that most of its directors believed the benefits of the peg outweighed the costs, provided current inflation pressures proved to be temporary.
“If, however, inflation should persist and the Gulf Co-operation Council (GCC) monetary union be delayed, they recommended to consider … alternative exchange rate regimes,” it added.
Inflation soared across the world’s biggest oil-exporting region as the ailing US dollar drove up import costs. But all six nations of the GCC have kept their currencies pegged to the dollar except Kuwait, which scrapped its link last year.
John Sfakianakis, chief economist at SABB bank, HSBC’s Saudi subsidiary, said Saudi Arabia’s decision-making elite would most likely overlook the IMF’s recommendation.
“The Saudis will not drop the peg. It’s just another recommendation … The IMF note had a sort of disclaimer by mentioning the advantages of maintaining the peg,” he said.
“The IMF is giving a tacit approval of the Saudi line on this issue because of the US clout in international financial institutions like the IMF,” he added.
The statement was not strong enough to compel Saudi Arabia, the GCC’s largest economy and the IMF’s largest Arab shareholder, to take action, said Shahin Vallee, currency strategist at BNP-Paribas. “It was a weak statement.
It provided approval to GCC authorities that the current arrangement is beneficial and benefits outweigh costs, providing short term support for the current regime: a smart political gesture from their part.”
The timing of the recommendation, as the dollar shows signs of relative recovery, even raises questions on the need for GCC member states to revalue their currencies to tame inflation, said Vallee.
“They are telling the Saudis the dollar peg is not the best arrangement and it’s not the only one … It has served you well in the past,” he said. “Because of the US dollar rebound, GCC countries will feel under less pressure to revalue. They will also feel they have more room to consider revaluation, away from market pressures and speculation.”
It would take a dramatic surge in inflation, a decline in disposable income and more pronounced public discontent for GCC governments to take action and reform their currency regimes, Sfakianakis said.
Dollar pegs have forced Gulf states to track US interest rate cuts even though their economies are booming due to a more than five-fold increase in oil prices in as many years.
The IMF said Saudi inflation is expected to end the year at 10.6%, implying it would remain flat in the six months to the end of 2008, as Saudi central bank governor Hamad Saud al-Sayyari has predicted.
Sayyari has repeatedly rejected dropping the dollar peg, citing the Saudi reliance on dollar-denominated sales of oil and the potential impact on foreign investors. The kingdom is trying to attract foreign investment to help diversify its economy and create jobs for its rapidly-growing population.
GCC countries are trying to forge a monetary union and launch a single currency in 2010. GCC leaders will meet in December to review the deadline.
But divergent inflation rates will directly affect interest rate policy and create imbalances in competitiveness within the bloc, said Sfakianakis. The currency plan has already been thrown into disarray twice after Oman decided in 2006 not to join and Kuwait severed its dollar peg in May 2007.
