Source: NCB Capital
If it ain’t broke … don’t fix it!
The Dollar pegs of the Gulf currencies are with increasing frequency being dismissed as an anachronism, inconsistent with the needs and economic realities of today. One of the main reasons for the criticism has been the divergence between the US and the GCC business cycles, which manifested itself with particular force in 2007-2008. Monetary easing in the US coincided with a robust oil-fueled boom in the Gulf and drove an unprecedented increase in inflation. However, the debate has been much more productive in identifying the shortcomings of the current exchange rate arrangement than finding a superior alternative to it. In reality, of course, no perfect policy exists, which is why the benefits of dropping the current regime should be weighed particularly carefully against the costs of doing so.
The US Dollar pegs of the five GCC currencies, bar the Kuwaiti Dinar, have become a favorite scapegoat for critics of economic policy in the Gulf. The high volatility of oil prices over the past couple of years has highlighted the challenge of managing the implications of the region’s continued high hydrocarbons dependence in the effective absence of monetary policy autonomy. Although many Gulf countries have had de facto Dollar pegs for decades, the current regime became official GCC policy as of 2003 as a deliberate precursor to the intended Gulf monetary union (GMU). With the union now delayed, the critics have gained some traction, although the arguments against hasty decisions remain numerous and compelling.