Sufficient foreign assets to help GCC maintain currency peg: S&P
Qatar has strong levels of foreign reserves to weather shocks of low oil prices and COVID-19
GULF Cooperation Council (GCC) sovereigns can maintain their pegged currencies as all of them have sufficient access to foreign currency assets or external financial support to meet pressures on their exchange rates, S&P Global Ratings has said in a report released on Monday.
The ability of Gulf countries to defend their currencies’ pegs, to the dollar in most cases, has come under scrutiny as historically low oil prices and the fallout from the coronavirus pandemic have pressured their economies.
The S&P, however, is of the opinion that the six GCC nations will maintain their pegged currencies despite a fall in oil prices
While Qatar, Kuwait, the United Arab Emirates, and Saudi Arabia have strong levels of reserves to weather shocks, S&P said, Bahrain and Oman have a lower level of external liquid assets.
The rating agency, however, believes that Bahrain and Oman’s wealthier neighbours would provide financial support in times of stress if needed, similar to a $10 billion aid package pledged to Bahrain by Kuwait, Saudi Arabia, and the UAE in 2018.
“We believe that should the currencies of lower-rated Bahrain and Oman come under significant pressure, higher-rated sovereigns would provide financial support to prevent contagion to their own financial markets,” S&P said.
S&P said that while a floating exchange rate can act as a shock absorber for small open economies by helping exports and domestic demand and output, the benefits in many cases for the GCC are limited because of their small non-hydrocarbon export base.
“We note that currency devaluation would increase the local currency value of US dollar-priced oil- and gasrelated revenues. This would improve government fiscal balances as long as governments are able to contain their spending, which may not be so easy given the inflationary aspects of such devaluation,” it said.
“Importantly, in terms of reducing pressures on GCC exchange rate pegs, we expect oil prices to recover in 2021, with Brent averaging $50 during the year, up from $30 in 2020. This will provide key support to the economies and foreign reserves positions of GCC central banks. The longer oil prices remain low, the higher the likelihood that pressure would increase on GCC exchange rate pegs,” the report said.
“However, for most of the GCC countries, our oil price assumption for 2021 is below the IMF’s respective fiscal breakeven oil price. This suggests that fiscal pressures will not be completely alleviated in the region, particularly with regard to Bahrain and Oman,” it said.
S&P said that fixed exchange rates have worked well for the GCC through various oil price peaks and troughs.
“This reflects the reality that energy production makes up a sizable share of gross value added in the region. Given the dollar-based nature of their economies, the pegs have provided a nominal anchor for inflation, supporting monetary policy credibility by outsourcing it to the US Federal Reserve,” it said.