In Qatar, Qatar Central Bank (QCB) adopted the exchange rate policy of its predecessor, the Qatar Monetary Agency, by fixing the value of the Qatari Riyal against the USD, at QR3.64 per USD. In July 2001, the targeted peg was officially authorised by Emiri Decree No.34, substituting the exchange rate policy of pegging to the Special Drawing Rights (SDR), which was in force since 1975. Apart from GCC countries, there are 60 other countries that have opted to peg their respective currencies to the USD and accept it as legal tender or manage their currencies against it. In the absence of a fixed peg, Qatar would have been exposed to exchange rate pressures faced by other emerging economies. Every time the US Dollar fluctuates sharply, as it did couple of times in the past few years, questions have been repeatedly raised over the independent monetary policy plaguing Gulf countries that peg their currencies to the dollar. With decline in value of the greenback, Qatar and other GCC members were stuck with large reserves of a devaluing currency. Though Qatar's link to the US economy is diminishing as a growing proportion of its trade and capital flow shifts towards Asia, it has roughly $150 billion in US bonds and its revenue from hydrocarbon sales is also denominated in dollars. This has invoked a question by many - will a currency be better off pegged or de-pegged?

There has been a growing consensus in the last few years, especially in emerging market countries, that the primary or overriding long-term goal of monetary policy should be 'controlling inflation'. In order to achieve the desired inflation, the popular choice is to peg their currency to that of a bigger economy with low inflation, typically the United States. Currency pegging simply means a country fixing the exchange rate of its currency to the currency of another country, with an underlying intention to control the value of its currency by using a fixed exchange rate. This implies that when the value of USD fluctuates relative to other currencies, the pegged currency undergoes a similar variation in value. Another reason why newly industrialized countries peg their currencies to the dollar is to increase exports. It gives them a comparative advantage, by making their exports to the US cheaper. A great example is China which pegs the Yuan to the dollar to maintain competitive pricing. Other countries such as the oil and gas exporting members of the Gulf Cooperation Council (GCC), peg their currency to the dollar because their primary export is sold in dollars.

Risk associated with pegging
In the past few years we have witnessed how currency crises can doom economies in emerging markets such as Mexico, South Korea, Thailand, Indonesia, and Malaysia, exemplifying how dangerous exchange rate peg can prove to be. Qatar remains in the dilemma that is typically confronted by monetary authorities of pegged regimes - it cannot reduce interest rates at the same pace as the US Federal Reserve thanks to high liquidity and inflation. This will gradually result in a widening gap between US and Qatari interest rates. Regulators then will be left with the option of either restraining liquidity or, if inflation remains consistently high, raising interest rates that would enhance the speculation about de-pegging the riyal. According to the "Impossible Trinity" model, Qatar broadly has three options; fixed exchange rate, free capital movement, and an independent monetary policy. The model says that a country can implement at best any two options at a time. Assuming if fixed exchange rate regime is applied, then it can either choose free capital movement or an independent monetary policy.

De-pegging: not a risk-free proposition
Monetary policy flexibility is lost due to pegging, as policymakers are forced to largely mirror the Federal Reserve's actions in order to prevent 'carry trades'. This refers to a situation where traders take advantage of low interest rates in one country to borrow currency and to invest in higher interest bonds or certificates in another country. The absence of the peg would have warranted capital controls in the region as implemented by export driven economies such as Brazil, Korea, Thailand, and Indonesia and/or continuous intervention by the central bank in the foreign exchange market, in order to keep the exchange rate at the target level. Flexible currency mechanism allows surplus countries' currency to appreciate over time, thereby making their products more expensive and, in worst case, can also lead to Dutch Disease.
In 2007, Kuwait became the sole Arab Gulf nation which de-pegged its currency, from the greenback and linked it to a basket of currencies. Although authorities did not reveal the exact composition of the basket the dinar tracks, it is estimated to have a 70-80% USD component. National Bank of Kuwait, estimated that the appreciation of the dinar against the dollar may have helped cut inflation level by around 1%. However, it hasn't resolved the state's inflationary problem completely, as its fiscal policy is expansive and domestic demand growth is quite strong. Although de-pegging might lag the inflation in Kuwait behind the rate of increase elsewhere in GCC, the upward pressure on prices will persist.

The possibilities for the Qatari Riyal
One of the key advantages that an independent monetary policy provides (if architectural tools are present to manage that) is that countries can back their currency issuance with sovereign bonds denominated in local currency. Time is ripe for Qatar to start working towards developing the market and architectural requirements for a managed float exchange rate supported by more sophisticated policy mechanisms. The sovereign right to print and manage the state's currency in accordance with domestic economic requirements should be reclaimed and cherished. Qatar can contemplate moving gradually from the current single peg toward a more flexible exchange rate, in order to avoid an abrupt change that might disturb the existing market credibility. In the last few years Qatar's institutional capabilities have rapidly evolved and it is now in the ideal position to seriously start working towards de-pegging. To begin with, policymakers could consider moving towards tracking to a basket of two currencies consisting of the US dollar and Euro, which account for a giant share of Qatar's international trade and financial transactions. With the challenges facing the U.S. economy and a trajectory of dollar weakness, questions about the future of the peg aren't likely to disappear and it might be an opportunity for policy makers to demonstrate proactive approach towards it.

Arguments against pegging

  •     Loss of independent monetary policy of the country, exposing it to the transfer of economic shocks from the anchor country.

  •     Increase in the possibility of speculation and also diminishing accountability of policymakers to pursue anti-inflationary policies, as pegging handicap becomes an excuse for justifying  inaction.

  •     Increase in financial fragility and making the country more prone to financial crises

© Qatar Today 2013