As the oil price hit its highest level in a year, and the dollar slumped to a new 2009 low against the euro, Gulf economists assessed the impact of these macroeconomic developments on the region’s growth. In a wide ranging discussion at the Middle East Investments Summit, hosted by Marcus Evans on 19-21 October in Dubai, they also gave their views on GCC monetary union and obstacles that need to be overcome to allow the region to emerge with renewed strength from the global recession. Melanie Lovatt reports.

The dollar continued its slide in October against many other currencies, particularly the euro, and crude oil prices maintained their strong inverse relationship, edging above $80/B to reach the highest level so far this year. Generally, WTI at $70-80/B is viewed as sufficiently high to allow producers to continue with most investment plans, and at the same time appears to encourage robust demand. But as it pushed slightly above this range, concerns were raised that further escalation may choke off the currently fragile economic recovery, given that last year’s jump (with a peak of $147/B in June) was a major contributor to the global recession. With the Gulf’s main product priced in dollars, and all but one of its six constituent countries’ currencies directly pegged to the dollar, there is a strong focus on its trajectory.

Weaker Dollar Benefits

The dollar may extend its decline slightly, but some believe that it is getting close to bottoming out. Any further weakness is likely to be underpinned by more coordinated responses from the US administration, although so far the authorities have been happy to let their trade deficit shrink. Around three-quarters of the US trade deficit is with China, while the rest is with OPEC countries, comments National Bank of Abu Dhabi’s Chief Economist and Head of Research, Asset Management Group, Giyas G?kkent, viewing the yuan as undervalued, and the euro fairly priced at current levels. However, Eckart Woertz, Program Manager Economics, at the Dubai-based Gulf Research Center cautioned that “last year the dollar’s weakness has turned to strength as excessive indebtedness led to a short squeeze in the dollar.” He said that with quantitative easing this crisis has been averted but it has also led to renewed dollar weakness. “The depreciation ahead might be more in real terms than in relation to other currencies, as those have their problems as well. The Euro for example has no centralized and unified fiscal policy,” he added.

However, if the dollar moves convincingly into the €1=$1.50-1.60 range, Tim Fox, Chief Economist at Emirates Bank NBD, expects more activism from the US authorities to support the beleaguered currency. Also, when interest rates start to climb from their recent lows, as would be expected upon economic recovery, dollar denominated investments will attract more demand, and thus boost the dollar itself. US interest rates are unlikely to rise again until the second half of next year, although some movement in the first half is possible, said Mr Fox. During the current recovery “markets contain bubble-like qualities, so we need to return to a normal interest rate structure sometime soon,” he warns.

The dollar’s falling value and its waning dominance as a global reserve currency have led many to question the wisdom of continuing to price crude in the US currency. Discussions on moving towards a basket of currencies have so far been theoretical, with Gulf oil producers vehemently denying that they are planning to change their long held practices any time soon, while those that have made a move to euros, namely Iran and Venezuela, have been responding to politics, not practicalities.

While the US’ hegemony as a reserve currency is being eaten away, most see it remaining dominant for the foreseeable future. “It’s true that there will be a lesser role for the dollar, but the US will remain as one of the largest economic areas and its currency will therefore have a function,” said the Dubai International Financial Center’s Director of Macroeconomics and Statistics, Fabio Scacciavillani, pointing out that the pound remained a major currency “long after the UK lost prominence in the world economy.” He puts long term euro-dollar parity at around the €1=$1.20 level.

Tied To US Monetary Policy

US exchange rate policy is of prime importance to GCC countries, given that all, with the exception of Kuwait, are directly pegged to the dollar, and even the Kuwaiti dinar is linked to a dollar-weighed basket of currencies. A couple of years ago, before the crisis hit full force, as Gulf economies were overheating and the US was trying to maintain economic growth, US interest rate cuts had to be followed by the Gulf, in order to discourage currency arbitrage. This compounded the problem, and it was clear that the peg left Gulf authorities without the monetary tools that would typically be used to control inflation. Currently, with the region also seeing the impact of the recession, this is not an issue, but inflation could resurface again, and fear that this situation will be revisited has been one of the main reasons behind the plan to implement a single GCC currency by 2010.

GCC Monetary Union Setbacks

However, with both the UAE and Oman pulling out, and Kuwait expressing reservations about the implementation schedule, the timing is looking uncertain. The exits make GCC union less relevant. “The importance of the GCC union is overrated and does not matter a lot without the UAE and Oman,” remarks Dr Woertz, suggesting that the customs union is now more important. The main obstacle to the currency union is harmonization of financial rules and regulations, explains Dr G?kkent, suggesting that the dollar peg should make integration easier than it was for  EU countries, and that the benefits should outweigh costs. Revisiting the high inflation seen in 2007 and early 2008 is unlikely in the near term, which buys some time for deliberations. Dr G?kkent, for example, does not expect inflation to rebound over an 18-24 month horizon.

Oil Climb Supportive

Although the dollar slide makes imports of equipment and services more expensive from non-dollar countries, the region’s economies are being supported by the up-trend in oil prices. With levels now above forecasts for GCC and OPEC 2009 budgets, many producing countries will reduce their expected deficits, or in some cases post a surplus (MEES, 19 October). Dr G?kkent notes that Dubai crude has averaged $56/B year-to-date, and he expects it to hover in the $75/B range, resulting in an average price of $60/B for 2009. He sees the 2010 price at an average range of $70-75/B. Mr Fox forecasts $80/B for the next 12 months, but warns that overly high prices would be a concern. Generally, the oil producers themselves would be unhappy with another $147/B peak because it encourages substitution and discourages consumption. “Although $100/B would be beneficial for basic balances it is important oil does not rally too fast – similar to the euphoria of 2008 – which would be negative from a global perspective,” suggests Mr Fox.

The oil price is aiding Gulf economic recovery, although economists are divided on their assessment of the recent upturn in equities, third quarter earnings and sentiment. Dr Woertz suggests the worst is not over and believes, in global terms, it will take a decade to work out. Dr Scacciavillani sees light at the end of the tunnel, but suggests that until the global artificial stimulus is withdrawn – which allows banks to get liquidity from central banks at zero interest rates and buy low risk government securities – credit will not flow to the real economy. Dr G?kkent touches on the potential for a “jobless recovery,” as highlighted recently by a number of experts, pointing out that unemployment is getting worse. “You may see a bounce in output, but will that trickle down to the labor market?” he questions. “There are cheerleaders, and some think there is a production-led boost, but comparisons are also being made with Japan’s lost decade,” adds Mr Fox, landing between these extremes and suggesting that 2010 will see a weak recovery accompanied by an overhang of public sector debt.

However, while the region has continued to depend heavily on oil earnings, Dr Scacciavillani stresses that over the last five to eight years, there have been attempts to diversify, and infrastructure spending has seen a huge boost. This has even continued during the crisis and will place the region among the world’s best performers, he said. Still, the region needs to further embrace the diversification and continue to focus on governance if it is to live up to its promise, these experts warn.

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