While the decision by Kuwaiti authorities on May 20, 2007 to abandon the dinar peg to the U.S. dollar has no impact on the sovereign ratings on the State of Kuwait and will help to subdue inflation, it casts significant doubt over plans to establish a monetary union across the Gulf States by 2010, according to a report published by Standard & Poor’s Ratings Services.
Prior to the decision, all Gulf Cooperation Council (GCC) states had their currencies pegged to the U.S. dollar, and it was widely assumed that the common currency in 2010 would also be pegged to the U.S. dollar. The common peg de facto fixed member states' currencies against one another, reducing uncertainty and transaction costs and simplifying coordination of monetary policy in the run up to monetary union, and would have ensured a smooth transition into a common currency.
“The common peg was a great support to union aspirations,” said Luc Marchand, credit analyst at Standard & Poor’s Ratings Services. “By virtue of pursuing policies that are beneficial to the national interest but that are potentially detrimental to the common goal, Kuwait's decision to switch back to pegging the dinar against a basket of currencies raises questions regarding the commitment of individual states to a monetary union, despite repeated official assurances to that effect.”
Technically, Kuwait's decision does not derail the common currency project, but will, in practice, add an extra layer of complication, Mr Marchand added. The peg for any common currency that involves Kuwait is now less likely to be the U.S. dollar, as it is unlikely that Kuwait will revert to such an arrangement in future. This raises the specter of negotiations among the six GCC states to agree to a common peg, with five currently opposed to abandoning the dollar.
Standard and Poor's expects the decision to repeg the dinar to a basket of currencies will have a positive impact on inflation. Although little is known at this point about the composition of the basket, other than that it will be trade-weighted, the move is clearly intended to halt the slide of the dinar vis-à-vis some of its trading partner currencies, and thus to dampen import prices and inflation expectations.
“The extent to which the repegging of the dinar will reduce inflationary pressures in Kuwait over the long-term will depend, in part, upon the composition of the new basket, and thus on the extent to which the dinar is delinked from the continued slide of the U.S. dollar going forward,” Mr Marchand said.
While a monetary union would certainly be a major step toward greater regional integration and cooperation, and holds much political and symbolic significance, Standard & Poor’s Ratings Services believes that its importance from an economic perspective has always been limited. Regional integration of fiscal and customs policies and of financial markets has been progressing independently of the question of monetary union.
“In short, the potential benefits from a future monetary union are not a support to the ratings of GCC countries, and thus any threat to its eventual inception will not impact upon the sovereign ratings,” Mr Marchand said.
© 2007 Al Bawaba (www.albawaba.com)
