Managing the currency peg

An adhoc revaluation of the USD peg is not the solution

April 07, 2008 -NCB Capital (NCBC) estimates that the GCC currencies have depreciated by over 37% in nominal terms since 2002 due to their peg to the US Dollar and discusses how the depreciating USD is affecting liquidity, interest rates and inflation. The report explains how the significant changes in the macro environment in recent years have changed key conditions required for hard currency pegs, increasingly making it look like trying to fit a square peg to a round hole.

The most appropriate policy response in their view would be a change of peg to a basket of currencies, simultaneously accompanied with a small one-time revaluation to offset part of the sharp loss in value of local currencies. Mr. Bryan D'Aguiar, Head of Equity Research of NCB Capital said, "Any move towards a change of the peg to the US Dollar needs to be conducted in a transparent manner, with the components and weights publicly disclosed, in order to avoid speculative pressures"

A larger revaluation would be counter-productive, as it would impair budgetary balances and current account surpluses, in addition to translation losses on the large pool of dollar denominated assets that oil revenues have bought into. Additionally a move to a free float would not be advisable at this time as the region lacks a well-developed debt market that helps transmit interest rate signals - an important pre-requisite for monetary policy to function effectively in a floating-exchange rate regime. The report analyses other possible scenarios and highlights the beneficiaries and losers of each.

The report titled 'GCC Currencies - A Square Peg For A Round Hole' is the first in a new series called 'In Focus', aimed at providing investors with independent analysis, views and opinions on key issues facing regional markets.

The report highlights how the GCC central banks have the unenviable task of conducting independent monetary policy in a fixed exchange rate regime that allows for free capital flows. It describes how the decades old dollar-peg has come under increasing calls for a review as falling interest rates, a steady decline in the value of the US dollar against major global currencies, and increased economic prosperity driven by record high oil prices translate into a flood of liquidity into the region driving inflation and increasing the challenges to regulators in effectively managing monetary policy.

"We estimate that the Saudi Riyal, UAE Dirham and Qatari Riyal have effectively depreciated 40%, 37% and 47% respectively in nominal terms since 2002, in a period in which the USD slipped 78% against the Euro. In contrast the Kuwaiti Dinar's peg to a currency basket has limited its depreciation to 23% ", according to Mr. Bryan D'Aguiar.

Interestingly, the report suggest that any revaluation would will not have a material impact on cushioning inflation in the short term, but would help achieve greater currency flexibility, a critical pre-condition for monetary-policy maneuverability. More importantly the current situation is an opportunity to push forward a structural change. In the event that a global slowdown materializes and oil prices decline, GCC surpluses will shrink. The burgeoning wage-bills and subsidies that have helped ward-off inflation thus far will become increasingly difficult to sustain thus making currency flexibility a critical policy tool.

Any revaluation would benefit global investors, capital-intensive industrial projects, companies with external liabilities, GCC importers and regulators. In contrast central banks would stand to lose as would exporters, investors, sovereign wealth funds, financial institutions and companies with dollar-assets, investments or foreign subsidiaries.

More information on NCB Capital, its business activities and products is available at www.ncbc.com

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About NCB Capital
NCB Capital (NCBC) is the asset management and investment banking arm of Saudi Arabia based The National Commercial Bank (NCB) - the largest bank in the Middle East in terms of capital ('The Banker' Magazine - 2007 Ranking). Headquartered in Saudi Arabia, NCB had total assets of USD 55.7 billion, shareholders' equity of USD 7.9 billion and managed investments of USD 22.8 billion as on December 31, 2007. NCB enjoys a credit rating of A+ from Standard & Poor's (S&P).

The company enjoys the distinction of being the first investment subsidiary of a local bank to be licensed by the Capital Market Authority (CMA) under the terms of its mandate that all banks in the Kingdom must separate their investment, brokerage and asset management activities from their commercial banking operations.

Capitalized at SR 1 billion (USD 267 million), NCB Capital is also licensed by the Central Bank of Bahrain as a Category 1 Investment Business, a license which allows it to deal in financial instruments as a principal, as well as undertake all other regulated investment activities.

NCBC aims to be the leading investment bank and asset management house in the region. NCBC offers corporate advisory services through its investment banking team and has an asset management team that manages local, regional and international assets across the full spectrum of asset classes. In addition, NCBC's brokerage team provides local and international brokering services for retail and institutional investors.

For further information please contact:
Salma Kanaan
TRACCS Public Relations
Phone: + 971 4 367 2530
Fax: + 971 4 367 2531
E-mail: salma@traccs.net