"The rise in inflation also has socio-political connotations and adds to the probability of GCC currency reform," the bank said in GCC Economics: Further into Negative, a report written by Dubai-based Monica Malik, senior economist at EFG-Hermes.
It also reiterated a 60-per cent probability that the UAE or Qatar, or both, may abandon the dollar-peg and move the dirham or rial to a currency basket during the first six months due to the "aggressive interest rate cuts" done by the US Federal Reserve this week.
But EFG-Hermes pointed out that the GCC countries, which move as a bloc, would more likely revalue their currencies than shift their peg to a currency basket.
It said that linking the currencies of the GCC countries to a basket of currencies would provide "greater money flexibility" which a one-time revaluation against the greenback could not. "We maintain our view…of a move away from the US peg in H12008 by one or more states (the UAE and/or Qatar) or the GCC as a whole," it added.
Market analysts have said that the slash in interest rates in the UAE and other GCC members, which followed the US Fed’s 75 basis points (bps) cut in interest rates to 3.5 per cent to ward off a recession, would stoke imported inflation across the Gulf region due to the depreciation of dollar-pegged currencies against the other currencies.
"The US rate cuts illustrate just how out-of-sync the GCC and the US economies are…." EFG-Hermes said, stressing that economic fundamentals have remained and interest rates low in the Gulf region despite strong economic activity on the ground and high credit growth and liquidity in the banking sector.
"These factors will continue to add to the inflationary environment," it said. It added that lending rates, which the GCC countries had kept at bay, would only have a limited impact on stemming credit growth.
"Firstly, given the strong level of liquidity in the banking sector, borrowing from the central bank is limited," it stressed. "Secondly, inter-bank rates are lower than central bank lending rates, thereby also reducing the incentive of commercial banks to borrow from the central banks."
Some estimates put at 10 per cent the UAE inflation last year from the 19-year high of 9.3 per cent in 2006 because of the weakening dollar while while EFG-Hermes said that inflation in Saudi Arabia surged to 6.5 per cent by end-2007, adding that Oman and Kuwait had also reached multiyear-high inflation rates.
Aside from Kuwait, which unshackled its dinar from the greenback in May, the currencies of Saudi Arabia (rial), Bahrain (dinar), the UAE (dirham), Oman and Qatar (both rial) are all pegged to the dollar.
"The aggressive rate cuts in the US increases the probability of currency reform in the GCC," EFG-Hermes said. "We have highlighted in our research that key factors in the timing of a move from the GCC will be aggressive interest rate cuts in the US and/or marked weakening in the US dollar."
The UAE and its Gulf neighbours said earlier that there would be no unilateral move to a currency basket from any of the GCC members.
