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GCC Currencies – To Peg or Not to Peg ?

January 12, 2016

 

Current slide in oil prices is at a very faster pace though Iran is yet to pump its excess oil in the global market. This is surely extremely painful for the oil producing countries, but for the moment they are looking helpless, as oil already lost more than 70 pct of its value in last 18-months

Two or three current developments are very dangerous for future oil prices and recovery looks remote. Apart from Geo-Political factor, which everyone knows that it may linger on for unknown period of time, Global Economic Meltdown, Strength of US Dollar and rising US Interest Rates are the added factors putting pressure on all Oil producing economies.

The next big question in everyone’s mind is that will the currencies of Middle Eastern Oil producing countries Survive Peg or will it remain glued to US Dollar? Minus Kuwait, which is pegged to basket of currencies is heavily tilted towards US Dollar, rest of GCC economies are pegged to USD at fixed rates.

Continued slide of oil prices since last one and a half years that has no stopping as yet is a matter of grave concern for the oil dependent economies. The problem is that GCC economies do not have independent Monetary Policy to guide its Currencies and Interest Rates to monitor according to its needs. Instead, it has to follow FED to maintain its parity with US Dollar and move in line with Money Supply Trend to manage its Interest Rates.

Both, holding of currency parity against USD and maintaining interest rate at current levels are a challenging and difficult task when US Dollar is gaining strength and FED is in a tightening cycle.

Budget deficit of GCC countries is ballooning and Economic Growth is slowing down. What bothers most in ongoing scenario is worsening of Balance of Payment position caused by exchange risk factor on country’s import and export.

Oil producing Middle Eastern countries is in a catch 22 situation, because de-pegging of currency has its own risk. It will shatter investor’s confidence resulting flight of capital and the currency will be exposed. Brazil and Russia are two very good examples.

As per rough estimate, average Budget Deficit in 2015 of GCC countries ranged between 10 to 15 pct of the GDP. If oil stays or dip below current levels, it will add to the misery.

If we have a look at 40-year oil history, in this era despite events such as Kuwait invasion, stock market crashes around the world, US Housing crisis, European meltdown, unrest causing Arab spring and now China getting squeezed, GCC currencies did manage to survive this Boom/Burst period successfully.

In this period, oil market even witnessed worst condition, as in 3rd quarter of 1986 oil prices averaged around $ 12, 1st quarter of 1994 it was averaging a notch below $ 15 and in late 1998 and early 1999 oil averaged around $ 11 per barrel. But this time Middle Eastern Oil producing countries are differently placed.

This is because if we make a price comparison or peep into the inflation basket of over 40-years, the project prices are roughly higher by 2 to 4 times. This is why oil prices ranging USD 15 per barrel was more sustainable then current price level of USD 31 per barrel.

Therefore, I see three possibilities in GCC zones. We are already witnessing the first phase in action in shape of subsidy cut and check on spending.

Second phase would push them to tap debt market and possible use of some part of their Reserves or even use funding from Sovereign Wealth Funds (SWF). Rough estimate of SWF amount is around US Dollar Two-Trillion. But in this phase drastic measures could also be taken such as slashing of huge projects and chopping of some part of costly defense budget. And finally dropping of peg will be the last option when oil prices will not be sustainable.

However, future of oil prices move will largely depend on combined factors involving Geo-Political situation in Gulf Region, OPEC production and pricing strategy, behavior of Trio Saudi Arabia/Iran/Russia and more importantly US Shale oil production should provide forward guidance about oil next trend. But all indicators suggest oil prices to remain depressed.

@asadcmka

(Disclaimer applies in my post, which means that the perspective is my personal view. I have made every effort to ensure accuracy of information provided. However, accuracy cannot be guaranteed. This article is strictly for information and not intended for Trade or Business Transaction) 

 

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