(Bloomberg) -- When central bankers in the Middle East say they have no plans to end their fixed exchange rates to the dollar, the currency market hears the opposite.
Merrill Lynch & Co. predicts either the United Arab Emirates or Qatar will cut their dollar peg within half a year. Standard Chartered Plc says the six Gulf Cooperation Council nations need to raise the value of their currencies 20 percent. The difference between the price of the Saudi Arabian riyal and the cost of buying it in a year using forward contracts has widened 10-fold since October as traders bet the kingdom will sever its 21-year-old link to the dollar, according to data compiled by Bloomberg.
``The dollar peg is doomed,'' said Jim Rogers, chairman of New York-based Rogers Holdings and a former partner of hedge fund manager George Soros.
The gulf countries, which supply 22.2 percent of the world's oil, according to BP Plc, are under pressure to abandon their fixed exchange rates after the dollar tumbled 10 percent against the euro in 2007. OPEC members Venezuela and Iran want to price more crude in other currencies. Inflation in the region is accelerating at the fastest pace in at least five years because central banks follow U.S. Federal Reserve policy.
The ties are already weakening. Kuwait dropped the dinar's fixed exchange rate in May and it has strengthened 4.5 percent.
Saudi Policy
U.A.E. central bank Governor Sultan Bin Nasser al-Suwaidi said last week that his country, a federation of sheikhdoms, may change its policy. The plan is ``not to drop the dollar peg but maybe to reduce it to a basket which will consist of more dollars, but not totally 100 percent,'' he said in an interview in Gwacheon, South Korea.
Gulf states will jointly discuss a proposal to revalue their currencies at a summit in Doha, Qatar, on Dec. 3-4, the secretary general of the Gulf Cooperation Council, Abdul Rahman al-Attiyah, told reporters yesterday in Riyadh, Saudi Arabia. Bahrain, Oman and Kuwait are also members of the council, known as the GCC.
Saudi officials rejected a suggestion by Iran and Venezuela to discuss ending the practice of pricing crude in dollars at an Organization of Petroleum Exporting Countries summit in Riyadh yesterday. The declining dollar's effect on oil revenues overshadowed Saudi attempts to highlight environmental issues.
``The dollar is in free fall, everyone should be worried about it,'' Venezuelan President Hugo Chavez said yesterday. ``The fall of the dollar is not the fall of the dollar, it's the fall of the American empire.''
`Worthless'
Saudi Arabia, the world's largest oil exporter, doesn't want the U.S. currency to ``collapse,'' and won't consider the proposal, Foreign Minister Prince Saud Al-Faisal said at a meeting of oil and finance ministers that was accidentally broadcast to journalists.
``They get our oil and give us a worthless piece of paper,'' said Iranian President Mahmoud Ahmadinejad yesterday. ``The dollar has no economic value.''
The U.S. Dollar Index, which measures its performance against six trading partners, has fallen 9.4 percent this year to a record low. The dollar rose 0.2 percent today to $1.4633 to the euro and fell 0.6 percent to 110.42 yen.
The fact that the link is being debated at all is a reflection of the weakening dollar and the decline of U.S. political and economic dominance. The currency accounted for 64.8 percent of world reserves at the end of June, down from 72.6 percent in 2001, according to the International Monetary Fund in Washington.
Alexander the Great
Abandoning the peg would risk driving prices higher for Americans, the biggest oil consumers. Oil rose 55 percent this year and was at $94.66 a barrel in New York today. It hit a record high of $98.62 on Nov. 7.
Reducing their dependence would also mark the increased wealth and power of oil producers. The GCC has never had an independent monetary policy. Before pegging currencies to the U.S., much of the region was under British influence and used the gulf rupee issued by the Reserve Bank of India and linked to the British pound. The U.A.E. dirham inherited its name from the Greek drachma, introduced in the Middle East in the third century B.C. by Alexander the Great.
The GCC hasn't been given new incentives to preserve fixed rates other than statements by Treasury Secretary Henry Paulson that the U.S. supports a ``strong dollar.'' The government hasn't intervened in the market to influence exchange rates since September 2003, the Federal Reserve Bank of New York said in a quarterly report to Congress on Nov. 8.
`A Dangerous Game'
U.S. policy makers are ``playing a dangerous game by allowing the dollar to depreciate so much,'' said Phil McHugh, a trader at Currencies Direct Ltd., an investment management company in London that oversees $2 billion. GCC officials would make ``a big statement'' if they revalue, he said.
If the GCC weakens its ties, oil producers will have less reason to recycle their revenue into dollar assets. OPEC members increased their holdings of Treasuries by 14 percent this year through September to $125.7 billion, Treasury data show.
Petroleum exporters are buying U.S. bonds three times faster than other foreign investors, the data show. Yields on 10-year notes are 21 basis points lower because of petrodollars, New York-based consulting company McKinsey & Co. said last month. A basis point is 0.01 percentage point. The 10-year note yield was at 4.16 percent.
``Government institutions and residents would likely move assets out of dollars into alternative currencies,'' said Tristan Cooper, senior sovereign analyst for ratings company Moody's Investors Service in Dubai.
Peg `Review'
The widening difference between prices for riyal and dirhams in the so-called spot market and the cost to buy them in a year shows traders expect the links to weaken.
Contracts to buy dirhams in 12 months rose 0.6 percent on Nov. 15, the most in 10 years, after al-Suwaidi, the central bank governor, said the dollar decline will trigger a ``review'' of the peg. The contracts traded at 3.58 per dollar today, compared with the currency's spot market rate of 3.6713, according to data compiled by Bloomberg.
The Saudi riyal rose as much as 0.8 percent to 3.7118 today, its biggest one-day advance since 1989, before paring its gain to 0.2 percent. Contracts to buy riyals in 12 months time rose as much as 0.9 percent to 3.66.
Saudi Arabian Monetary Agency Governor Hamad Saud al-Sayari said in an interview in Kleinmond, South Africa, yesterday that the issue of revaluation had been discussed by Gulf central bank governors a few weeks ago and ``we came up and said `no change in policies.' That is the agreement of the whole group.''
Wealthier Than Ever
Oil exporters are wealthier than ever after prices more than quadrupled since 2001. Crude averaged about $20 a barrel in the previous two decades. The IMF forecasts 5.6 percent economic growth in the gulf region for 2007, almost triple the 1.9 percent in the U.S.
Saudi foreign currency reserves increased 26 percent in the year to Sept. 30 to 969 billion riyals ($259 billion), according to the central bank. The U.A.E.'s reserves jumped 65 percent in year ended in June to 159 billion dirhams ($43 billion).
Faster growth and rising import prices caused by the sinking dollar are spurring inflation. Saudi Arabia's consumer prices rose at a record 4.9 percent pace in August, after averaging less than 1 percent over the last decade, government figures show. Inflation quickened at a 9.3 percent rate in the U.A.E. last year and reached an all-time high in Qatar of 14.8 percent during the first quarter.
Fed Rate Cuts
Gulf central banks can't raise borrowing costs to cool their economies because they must follow the Fed to maintain their pegs. U.S. policy makers reduced the target rate for overnight loans between banks twice since September to prevent the worst housing slump in 16 years from dragging the economy into recession.
``We will have more rate cuts by the Fed, more dollar weakness and probably still higher oil prices,'' said Hans- Guenter Redeker, head of currency strategy in London at BNP Paribas SA, France's largest bank. The chances that GCC nations get ``into a kind of boom-bust scenario is increasing, so it's urgently required to change that mechanism,'' he said.
Any shift to a floating exchange rate would hurt petrochemical and non-oil manufacturing exports, said A.F. Alhajji, an energy economist and associate professor of economics at Ohio Northern University in Ada, Ohio. Saudi Arabia will be reluctant to make pilgrimages to Mecca more expensive for the world's Muslims, he added.
Political Backlash
``Politically, there could be a backlash,'' he said. ``The people who will benefit the most will be foreign workers in Saudi Arabia.''
The dirham link was picked by 11 of 15 strategists and fund managers in a Bloomberg News survey as the most-likely to break. Qatar's riyal was chosen by three analysts and the Saudi Riyal by one. Bahrain's dinar was one analyst's second choice.
Gulf central banks are already preparing for an exchange rate regime that doesn't require dollars to defend.
The U.A.E.'s al-Suwaidi said his bank has a target of moving 10 percent of its reserves into euros and has ``already diversified to some extent.'' The $50 billion Qatar Investment Authority said Sept. 4 it was looking to buy assets in Asia to counter a weak dollar.
Scrapping the peg ``would further undermine the dollar,'' said Michael Hughes, who helps manage about $40 billion as chief investment officer at Baring Asset Management in London. ``There's no doubting that the events of the last few months have shifted the debate about what the appropriate monetary order should be worldwide.''
To contact the reporters on this story: Matthew Brown in Dubai at o mbrown42@bloomberg.net ; Aaron Pan in Hong Kong at Apan8@bloomberg.net .
