08 March 2017
The economic signs are getting clearer. The day that the Gulf Cooperation Council (GCC) countries decide to peg to a broader basket of currencies appears to be drawing closer. For the sake of argument, anyone who doubts that changes are in the wings should remember what happened to the Swiss Franc's peg to the Euro. Although the CHF-to-EUR parting of ways took the markets by surprise, in hindsight, all the signs were there.
Changes in monetary policy come when there is an extended period of weakness in the currency peg. Or when there are strongly divergent economic changes in the countries with the pegs. In 2015, the Euro became too weak for the Swiss National Bank (SNB) to keep subsidising the peg with the CHF. The slow growth in the Eurozone markets affected confidence from its trading partners. The peg proved to be no longer in the SNB's interest. Finally, its hold wasn't strong enough, sending the CHF and Euro in their own directions.
Going further back in time to Asia in 1997, the Thai baht was un-pegged from the USD during the Asian economic crisis. The main reasons for the shocking event were high deficits and rising debt levels at fixed exchange rates. The resulting loss of confidence meant that foreign investors took their money out of Asia. The cash crunch and bond repayment problems that followed triggered a wider regional slowdown. Stock market crashes took their toll and recovery took years.
In the case of the GCC countries' peg to the USD, there are also broader economic trends in play. GDP is diverging in the US versus the GCC countries, where growth has slowed down because of the reduced energy revenues. Also, GCC countries are undergoing extensive - and expensive - economic restructuring. While necessary in the long term, austerity is the resulting and prevailing economic trend.
Contrast the restrictions of austerity with the recent interest rate hikes taken by GCC regional central banks. Monetary policy makers have to keep up with the Federal Reserve, in line with the demands of the currency pegs to the USD. The interest rate policy limits the risk of capital outflows, but also means higher costs for servicing government and private debt. The costs of servicing debt comes from government tax and income revenues. Both have plummeted from pre-2014 levels. Meanwhile, deficits are rising. Saudi Arabia is running a deficit of $32 billion and the International Monetary Fund (IMF) forecasts its debt will reach 30 percent of GDP by 2021.
Higher interest rates mean that another slump in the key real-estate sector can’t be ruled out. The memories of the property bust in Dubai are only just fading away. They may see an unfortunate revival because interest rates in the US – and therefore in the GCC - are bound to keep rising, all the while impacting borrowing and investment power. The biggest question is whether economic growth and the USD currency peg can take the weight of more US interest rate hikes in the short term. Economic resurgence in the GCC countries isn’t expected until 2021, so there’s a serious downside to hiking interest rates further. The cash crunch isn’t likely to ease in the short-to-medium term either, given the prospects of more interest rate hikes between 2017 and 2018.
Comfortably sustaining the currency pegs may come down to an economic miracle like a strong resurgence in crude oil prices in the first half of 2017. So far, the crude oil prices are struggling to beat $54 a barrel, in the face of OPEC’s best efforts to cut supplies. The US shale industry is matching OPEC and Russia move for move. The result is a range-bound crude oil price, at least for the moment.
Barring such economic miracles in the energy markets, can the USD currency peg make it untouched until 2021, when the economic reforms in the GCC are expected to come into their own? It’s a race against time and economic circumstances. The USD peg has lasted 30 years, but now has to survive unprecedented economic divergence in the US and GCC countries. The GCC central bankers prefer the road more traveled, but if debt levels start seriously affecting economic performance, this could change – though hopefully not as shockingly as the Swiss and Thailand central banks did. The compromise way forward could be the much-discussed peg to a basket of currencies as a way of easing the pressure from a hawkish Federal Reserve.
Author's disclaimer: The content in this article comprises personal opinions and ideas and should not be construed as containing personal and/or other investment advice and/or an offer of and/or solicitation for any transactions in financial instruments and/or a guarantee and/or prediction of future performance. FXTM, its affiliates, agents, directors, officers or employees do not guarantee the accuracy, validity, timeliness or completeness of any information or data made available and assume no liability as to any loss arising from any investment based on the same.
Any opinions expressed here are the author’s own.
The economic signs are getting clearer. The day that the Gulf Cooperation Council (GCC) countries decide to peg to a broader basket of currencies appears to be drawing closer. For the sake of argument, anyone who doubts that changes are in the wings should remember what happened to the Swiss Franc's peg to the Euro. Although the CHF-to-EUR parting of ways took the markets by surprise, in hindsight, all the signs were there.
Changes in monetary policy come when there is an extended period of weakness in the currency peg. Or when there are strongly divergent economic changes in the countries with the pegs. In 2015, the Euro became too weak for the Swiss National Bank (SNB) to keep subsidising the peg with the CHF. The slow growth in the Eurozone markets affected confidence from its trading partners. The peg proved to be no longer in the SNB's interest. Finally, its hold wasn't strong enough, sending the CHF and Euro in their own directions.
Going further back in time to Asia in 1997, the Thai baht was un-pegged from the USD during the Asian economic crisis. The main reasons for the shocking event were high deficits and rising debt levels at fixed exchange rates. The resulting loss of confidence meant that foreign investors took their money out of Asia. The cash crunch and bond repayment problems that followed triggered a wider regional slowdown. Stock market crashes took their toll and recovery took years.
In the case of the GCC countries' peg to the USD, there are also broader economic trends in play. GDP is diverging in the US versus the GCC countries, where growth has slowed down because of the reduced energy revenues. Also, GCC countries are undergoing extensive - and expensive - economic restructuring. While necessary in the long term, austerity is the resulting and prevailing economic trend.
Contrast the restrictions of austerity with the recent interest rate hikes taken by GCC regional central banks. Monetary policy makers have to keep up with the Federal Reserve, in line with the demands of the currency pegs to the USD. The interest rate policy limits the risk of capital outflows, but also means higher costs for servicing government and private debt. The costs of servicing debt comes from government tax and income revenues. Both have plummeted from pre-2014 levels. Meanwhile, deficits are rising. Saudi Arabia is running a deficit of $32 billion and the International Monetary Fund (IMF) forecasts its debt will reach 30 percent of GDP by 2021.
Higher interest rates mean that another slump in the key real-estate sector can’t be ruled out. The memories of the property bust in Dubai are only just fading away. They may see an unfortunate revival because interest rates in the US – and therefore in the GCC - are bound to keep rising, all the while impacting borrowing and investment power. The biggest question is whether economic growth and the USD currency peg can take the weight of more US interest rate hikes in the short term. Economic resurgence in the GCC countries isn’t expected until 2021, so there’s a serious downside to hiking interest rates further. The cash crunch isn’t likely to ease in the short-to-medium term either, given the prospects of more interest rate hikes between 2017 and 2018.
Comfortably sustaining the currency pegs may come down to an economic miracle like a strong resurgence in crude oil prices in the first half of 2017. So far, the crude oil prices are struggling to beat $54 a barrel, in the face of OPEC’s best efforts to cut supplies. The US shale industry is matching OPEC and Russia move for move. The result is a range-bound crude oil price, at least for the moment.
Barring such economic miracles in the energy markets, can the USD currency peg make it untouched until 2021, when the economic reforms in the GCC are expected to come into their own? It’s a race against time and economic circumstances. The USD peg has lasted 30 years, but now has to survive unprecedented economic divergence in the US and GCC countries. The GCC central bankers prefer the road more traveled, but if debt levels start seriously affecting economic performance, this could change – though hopefully not as shockingly as the Swiss and Thailand central banks did. The compromise way forward could be the much-discussed peg to a basket of currencies as a way of easing the pressure from a hawkish Federal Reserve.
Author's disclaimer: The content in this article comprises personal opinions and ideas and should not be construed as containing personal and/or other investment advice and/or an offer of and/or solicitation for any transactions in financial instruments and/or a guarantee and/or prediction of future performance. FXTM, its affiliates, agents, directors, officers or employees do not guarantee the accuracy, validity, timeliness or completeness of any information or data made available and assume no liability as to any loss arising from any investment based on the same.
Any opinions expressed here are the author’s own.
