An Opec market share competition could push oil prices lower, increasing pressure on GCC pegs, but the core GCC USD pegs, including that of Saudi Arabia, are likely to hold at current oil prices, a report said.

The continuing large terms-of-trade shock has increased market speculation that the GCC USD pegs could break going forward, added the Bank of America (BofA) Merrill Lynch Global Research, titled “EEMEA Economic Weekly: GCC: Saudi USD peg to hold”.

“We continue to expect that the core USD pegs will likely hold over the medium-term and flag Oman’s peg as the most vulnerable,” explained Jean-Michel Saliba, Mena economist at Bank of America Merrill Lynch.


“Key to the view is a combination of still sizeable foreign assets in parts of the GCC and the apparent start of a regional multi-year fiscal adjustment process, rooted in the idea that the underlying cause of the regional macro imbalances root is unsustainable fiscal positions,” he said.

“Devaluation gains appear overstated given low Fx elasticity of external and fiscal accounts. Out of the three pillars of the regional macro view (namely, fiscal, energy and Fx policy), the first two pillars would see changes prior to the last (Fx policy) seeing reforms, in our view.

“We think that there are three aspects to consider when evaluating the future path of Fx policy in the GCC: willingness, desirability, and ability to maintain the USD pegs. We believe all GCC countries share a willingness and commitment to maintain unchanged Fx policies,” he added.

The USD peg has served the GCC well for decades by providing a nominal anchor to the economy and expectations, the report said.

The GCC pegs have permitted to the region to run broadly low inflation, to simplify trade and financial transactions, and to reduce uncertainty as to the domestic value of oil export receipts, the report said.

The relatively low export diversification (apart from the UAE) suggests non-oil sector competitiveness matters in a stronger USD environment are secondary in the short term. External stability is harder to assess as large current account surpluses during the oil boom partly reflect necessary intergenerational savings given finite oil resources.

“External deficits are thus the mirror image of this in the current situation. Exchange rates are likely currently misaligned but the equilibrium REER likely also depends on the medium-term level of oil prices which could rebound going forward,” said Saliba.

“While a more flexible Fx regime could allow the GCC to adjust to real shocks better, the gains in terms of room for conduct of independent monetary policy are curbed by existing institutional arrangements, underdeveloped instruments, as well as limited interest rate policy transmission mechanism, in our view. However, an upfront Fx devaluation would prevent further depletion of Fx reserve assets, especially if the willingness of authorities to implement sufficient fiscal consolidation is questioned.”

Ability to defend the USD peg varies

While all GCC countries have expressed their commitment to the USD pegs, their ability to defend the arrangements in a sustained oil price slump varies greatly.

“Within the GCC, we believe Kuwait, Qatar and the UAE are still in a comfortable position given fiscal breakeven oil prices of $50-65/bbl and fiscal buffers that can cover deficits incurred under $30/bbl for 15-20 years. At the other end of the spectrum, Saudi Arabia, Bahrain and Oman are more challenged as fiscal buffers would be exhausted within five years under the same set of assumptions,” Saliba concluded. – TradeArabia News Service