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Dubai: Gulf currencies except the Kuwaiti dinar depreciated more than 37 per cent since 2002 against a group of 11 currencies that dominate the region's trade basket, according a statistical estimate by Saudi Arabia-based NCB Capital, the investment banking arm of National Commercial Bank.
The currency depreciation effectively means higher imported inflation in the region adding to the overall inflation caused by structural factors such as supply shortages and surging demand due to the economic boom.
Currency flexibility enabled Kuwait to limit effective depreciation in the dinar to 23 per cent. According to NCB Capital's estimates the Saudi riyal, UAE dirham and the Qatari riyal have effectively depreciated 40 per cent, 37 per cent and 47 per cent respectively in nominal terms while the dollar declined 78 per cent against the euro and 40 per cent against sterling.
In the context of currencies being forced to decline in nominal terms because of the dollar peg, the Gulf governments' retention of the currency peg has come under increasing calls for a review as falling interest rates, a steady decline in the US dollar, and record high oil prices translate to a flood of liquidity and rising inflation.
"The most appropriate solution is a change of peg to a basket of currencies accompanied by a small one-time revaluation (say 4-5 per cent) to offset part of the sharp loss in value of local currencies)," said Bryan D'Aguiar, head of equity Research of NCB Capital.
However, he argues that a larger revaluation would be counter-productive, as it would impair budgetary balances and current account surpluses. In addition, the regional governments and central banks will incur translation losses on the large pool of dollar denominated assets they already hold.
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 in a floating-exchange rate regime.
According to NCB Capital, the currency basket against a potential future peg should be decided on a trade weighted basis.
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