- The Washington Times - Tuesday, March 18, 2008

KUWAIT CITY (AP) - Kuwait’s decision to stop pegging its currency to the dollar last year hasn’t completely tamed inflation, but experts say many of its oil-rich neighbors will follow, desperate to fight the effects of a weak dollar.

Oil is priced in dollars on the world market, but many Gulf countries rely on government-subsidized imports priced in euros and other currencies that have been rising against the greenback.

This relationship has pushed up the price of imports, a situation that could worsen as fears of a recession in the U.S. and related interest-rate cuts continue to push down the dollar. Raising their interest rates would have little effect on the Gulf states’ inflation rates while their currencies remain pegged to the dollar.

Finance experts are divided on how big an effect depegging would have on the value of the U.S. dollar. Ali al-Mousa, a former deputy governor of the Central Bank of Kuwait, said investment flows into the U.S. economy were more important.

“Look at what is going on right now,” he said. “Billions are directed to the U.S. in investments. What is more important? These billions going to the U.S. or the Kuwaiti dinar being de-pegged from the dollar?”

Reyadh Faras, an economics professor at Kuwait University, disagreed.

He said that Kuwait’s decision to abandon the dollar was significant and that similar decisions by even larger countries could seriously erode the dollar’s value.

“If large countries like [Saudi Arabia] take the same step, its psychological effect will precede its actual one, and it could lead to losses for the dollar,” he said.

“Inflation is likely to stay on an increasing trend in the short term,” said a Merrill Lynch report on Gulf nations published in January. With few other fiscal policies available to control inflation, the region’s governments would consider de-pegging or revaluating their currencies, the report speculated.

Alan Greenspan, former chairman of the U.S. Federal Reserve, said at an economic forum in Saudi Arabia last month that depegging from the dollar would significantly help Gulf states battle rising inflation in the short term.

Merrill Lynch predicted Qatar and the United Arab Emirates, suffering from inflation rates of 14 percent and 10 percent, would revalue their currencies relative to the dollar or de-peg. As with Kuwait’s decision, a move by Qatar or the UAE would likely anger their U.S. ally.

In a January interview with Kuwait’s Aljarida daily, Steve Conlon, an economic officer at the American Embassy, said Washington was unhappy with Kuwait’s currency move because it showed no confidence in the strength of the dollar.

Saudi Arabia, the world’s largest exporter of oil and a very close ally of the U.S., has discouraged Arab states in the Gulf from following in Kuwait’s footsteps. Saudi Arabia’s finance minister, Ibrahim al-Assaf, said in December that any move to de-peg from the dollar would be an unanimous decision by members of the Gulf Cooperation Council, a loose alliance of six countries — Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates — that pump one-fifth of the world’s oil.

Appearing alongside Mr. Greenspan in Jidda, the vice governor of the Saudi Arabian Monetary Authority, Mohammed al-Jasser, advised against drastic moves in response to dollar weakness.

“This is not the first time that the dollar loses value. It’s part of the business cycle,” he said.

However, Saudi Arabia is less vulnerable to the inflationary effect of the falling dollar because it has a strong domestic industrial base and grows some of its own food. It relies less on pricey imports and had a more manageable inflation rate of 6 percent in 2007. Many smaller countries in the Gulf like Kuwait, Qatar and the UAE import almost everything but oil, leaving them more exposed.

Ibrahim al-Ibrahim, an economic adviser to Qatar’s emir, told the Gulf Times in January that de-pegging the riyal from the dollar was one option his country was examining to battle inflation. Other countries, like the UAE, have toed the line and said they are sticking with the dollar, but pressure will continue to build if the value of the dollar remains low.

“I think any central bank will do their utmost, and they will not belittle any measure which can contribute to sort of controlling inflation at any level,” said Mr. al-Mousa.

Kuwait’s decision to de-peg from the dollar last May led the dinar to appreciate 5.9 percent through the end of 2007, making imports less expensive. However, economists estimate that some 70 percent of Kuwait’s inflation results from government expenditures of huge oil revenues, a situation faced by other Gulf countries as crude prices hover near record levels. The dollar also has considerable weight in the basket of currencies to which the Kuwaiti dinar is now tied.

Economists say it will take time for the effects of the currency move to work through the economy. Merrill Lynch estimated inflation in Kuwait would rise from 5 percent in 2007 to 7 percent in 2008 and then decline to 6.2 percent in 2009.

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