GCC Dilemma: The Price to Pay for Stability

The GCC countries have enjoyed the benefits of a currency peg to the USD for decades. It has helped to protect the local economies during times of global economic dislocation by maintaining a key stabilizer. They are able to maintain these pegs due to their substantial USD oil export revenues. There have been times in the past when speculation was ripe that the GCC currency pegs would break. The last time was when oil prices collapsed in 2014, and there were advocates then for a move to a floating rate currency. We believed then and continue to believe now that a change in the currency regime in the region would be more detrimental as the cost of imports – the region imports virtually everything – would skyrocket, as would inflation. The region is now in a unique predicament; inflation is relatively low across the region, but central bankers are forced to follow the Fed and raise interest rates. To put it into perspective, the UAE and Saudi have inflation running at 3.4% and 2.3% respectively, well below the US’s 8.6%. After the recent policy rate moves, real rates are virtually back to neutral in most GCC countries. But the Fed is far from done in raising rates, so the GCC central banks will have to continue to tighten policy with higher rates when they don’t need to. This could have a negative impact on growth as interest rates move too high. The price to pay for stability.