Qatar is in a “comfortable position” to defend the riyal’s peg to the US dollar given its fiscal breakeven oil price and buffers, according to the Bank of America Merrill Lynch.
While all GCC countries have expressed their commitment to the dollar pegs, their ability to defend the arrangements in a sustained oil price slump varies greatly, it said in its latest economic report.
“Within the GCC, we believe Kuwait, Qatar and the UAE are still in a comfortable position given fiscal breakeven oil prices of $50-$65/barrel and fiscal buffers that can cover deficits incurred under $30/b for 15-20 years (conservatively assuming no debt financing and at unchanged spending policies).
At the other end of the spectrum, Saudi Arabia, Bahrain and Oman are more challenged as fiscal buffers would be exhausted within five years under the same set of assumptions,” BOAML said.
The report said the continuing large terms-of-trade shock has increased market speculation that the GCC (Gulf Cooperation Council) dollar pegs could break going forward. But BOAML continues to expect that the core dollar pegs will likely hold over the medium-term and flag Oman’s peg as the most vulnerable.
Key to the view, it said is a combination of still sizeable foreign assets in parts of the GCC and the apparent start of a regional multi-year fiscal adjustment process, rooted in the idea that the underlying cause of the regional macro imbalances root is unsustainable fiscal positions. Devaluation gains appear overstated given low forex elasticity of external and fiscal accounts. Out of the three pillars of the regional macro view (namely, fiscal, energy and forex policy), the first two pillars would see changes prior to the last (forex policy) seeing reforms, in BOAML’s view.
The bank thinks there are three aspects to consider when evaluating the future path of forex policy in the GCC - willingness, desirability, and ability - to maintain the dollar pegs. It believes all GCC countries share a willingness and commitment to maintain unchanged forex policies.
As for desirability, considerations should broadly favour the status quo to the extent that the fiscal costs attached to it can be managed, in the bank’s view.
“The dollar peg has served the GCC well for decades by providing a nominal anchor to the economy and expectations, in our view. The optimal choice of an exchange rate regime should yield external (no real effective exchange rate or REER misalignment) and internal (low inflation) stability, preserve monetary credibility and competitiveness, and reduce balance sheet risks and transaction costs,” BOAML said.
In this respect, the GCC pegs have permitted the region to run broadly low inflation, to simplify trade and financial transactions, and to reduce uncertainty as to the domestic value of oil export receipts. The relatively low export diversification (apart from the UAE) suggests non-oil sector competitiveness matters in a stronger dollar environment are secondary in the short term.
“While a more flexible forex regime could allow the GCC to adjust to real shocks better, the gains in terms of room for conduct of independent monetary policy are curbed by existing institutional arrangements, underdeveloped instruments, as well as limited interest rate policy transmission mechanism, in the bank’s view.
“However, an upfront forex devaluation would prevent further depletion of forex reserve assets, especially if the willingness of authorities to implement sufficient fiscal consolidation is questioned,” BOAML said.