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Pressure mounts on exchange rates

Soaring oil revenues are putting pressure on the dollar-pegged exchange rates in the Gulf, since the green buck is expected to continue to decline, and most GCC trades are denominated in other currencies.

Soaring oil revenues are putting pressure on the dollar-pegged exchange rates in the Gulf, since the green buck is expected to continue to decline, and most GCC trades are denominated in other currencies.

Around half of imports in the region are priced in euros, but gulf oil exports are traditionally traded in the US dollar.

According to the Dubai Chamber of Commerce, the Saudi riyal is undervalued by as much as 33% relative to the dollar. The UAE suffers the least from all GCC currencies, with the dirham being undervalued by 12%.

Stephane Garelli, Professor at the Institute for Management Development (IMD) at the University of Lausanne, said at the business leaders in Abu Dhabi summit last week, “The dollar will continue to depreciate, and this will cause problems for countries like the UAE.”

“The dollar, which had a 0.9 exchange rate against the euro in 2002, and now 1.27 in 2006, will continue to fall, and this poses a serious problem for countries or corporations that manufacture or import in euros and sell in dollars,” Garelli said.

All GCC countries are pegged to the dollar, and when they form a monetary union in 2010 they are planning to keep the peg.

“Pegging the exchange rate to the dollar has one effect, but the consequent interest rate peg has a different impact,” said Andre Sayegh, CEO, First Gulf Bank.

Sayegh said targeting inflation could also be carried out through other means such as fiscal as well as monetary measures.

Since a week dollar tends to increase inflation due to the trading in goods of different currencies analysts say a revaluation would be necessary - besides international authorities calling for greater exchange rate flexibility in order to reduce global imbalances.

Revaluation however can only happen when all GCC member states coordinate among each other. Also, many goods within the gulf are traded in dollar and would then be pricier.

“Most Saudi assets are in dollars and if they revaluate they will take a loss on that. It’s not something they will do lightly," said Richard Fox, credit analyst at Fitch Ratings in London.

Last week the riyal was foreseen to be revalued over the Eid holiday, but analysts say that politics as well as economics made such as move unlikely.

The Saudi riyal was traded at a record peak up to 3.7420 per dollar- its highest since last May when investors first believed that Saudi Arabia would revalue its currency along with the Kuwaiti dinar, a more flexible currency than the Saudi riyal, that was then allowed to appreciate against the dollar.

All Gulf markets were closed for the Eid Al Fitr holidays for most of last week – with all dealings in currencies being offshore and traders said thin liquidity was exaggerating moves.

The move was just 0.16% but is significant for the riyal, which is closely pegged to the dollar at 3.75. Economists now say that, if it firms beyond 3.75 without a response form the central bank, speculation about a revaluation may heat up.

“The riyal moves are being caused by the rumours of revaluation. There was a liquidity squeeze in the market that made the riyal spot move well under 3.75,” said Koceila Maames, Middle East and North Africa economist at Calyon Paris. “From an economic point it does not really make sense, but you can’t rule it out as political gesture – as a gift to the population for Eid.”

“Some dealers are heard touting a move up to 15%," he added.

According to the annual report of the International Monetary Fund (IMF), in its first assessment of the Saudi economy following its World Trade Organisation (WTO) membership last year, the Saudi riyal appreciated by 3.4% in real effective terms during the 12-month period through March 2006, reflecting the movement of the US dollar against other major currencies.

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