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Dollar to fade, not fly, from scene as Gulf reforms
By Daliah Merzaban
Wednesday, November 21, 2007
DUBAI -- Gulf exchange rate reforms would barely dent demand for dollars in six oil-producing states with $1.2 trillion in reserves but they would signal the U.S. currency's gradually diminishing importance to the region.
The United Arab Emirates' appeal last week for Saudi Arabia and its neighbors to swap dollar pegs for currency baskets have weighed on the dollar, partly on expectations that investors of Gulf reserves would soon have less reason to buy U.S assets.
The region's sovereign wealth funds are already investing more in Asia and countries such as India and China are growing in importance as consumers of Gulf oil and gas.
Still, investors in dollar assets have little to fear from currency reform in the Gulf. Anything that would hurt the dollar would backfire on countries that have overwhelmingly invested in U.S assets and depend heavily on dollar-denominated oil revenue.
"We strongly believe the Gulf will not surprise global markets with a sudden change in currency regime," Citigroup Global Markets Economist Mushtaq Khan said in a note.
"The Gulf realizes that an abrupt shift could upset the markets by raising questions about its appetite for dollars," he said.
In a region of U.S. allies, the Gulf reform debate bears no resemblance to the rhetoric of Iran or Venezuela, which spooked foreign exchange markets by pressing fellow oil exporters of the OPEC cartel last week to have crude priced in other currencies.
Gulf Arab states have in past ruled out accepting payment for oil in anything but dollars, and even those that have pushed hardest for an end to fixed exchange rates, such as Kuwait and the UAE, have never said they are bearish about U.S. assets.
The push for reform stems not so much from dollar weakness as from a growing consensus that dollar pegs have outlived their usefulness in booming economies which are increasingly out of step with a United States trying to contain a downturn.
With the Federal Reserve cutting interest rates, Gulf central banks have been forced to follow and ignore the risk of stoking inflation at decade highs across the region.
UAE Central Bank Governor Sultan Nasser al-Suweidi talked of the need to unshackle monetary policy from the Fed when he called for an end to dollar pegs. Any basket that replaces them would be dominated by the U.S. currency, he said.
Kuwait, which broke ranks with its neighbors and scrapped its peg in May, tracks the dinar against a basket that the central bank says is largely dollar based, mirroring the currencies in which it pays for imports and investments.
"The composition would be very similar in other Gulf states," said Caroline Grady, Deutsche Bank's regional economist.
Even if were not, central banks would hardly need to shift away from dollars to maintain a new exchange rate regime, said Jessop Julian, chief international economist at Capital Economics in London.
"Funds for market intervention can be held in any liquid currency," Julian said in a note. "The choice of currency regime and the desire to hold a large share of reserves in dollar assets are therefore two separate decisions."
Were they to shift, central banks will act gradually, guided by commercial considerations, analysts said.
Saudi Foreign Minister Saud al-Faisal blocked calls from U.S. adversaries Venezuela and Iran for OPEC to include concerns about dollar weakness in a summit communique last week. The mere mention of it could hurt the dollar, he said.
"Even if there were to be a change in currency regime in parts of the Gulf, they would stay close to the dollar, at least for as long as oil is priced in the U.S. currency," said Simon Williams, HSBC's senior regional economist.
While it should be no surprise that the curtain is coming down on U.S. currency's reign over Gulf economies and investments, that is a long-term shift linked more to the rise of Asia than the diminishing stature of the United States.
The Kuwait Investment Authority, which said it had at least $213 billion in assets on March 31, decided in 2005 to double its allocation for Asia to 20 percent of its portfolio.
The $650 billion Abu Dhabi Investment Authority is seeking to invest more in emerging markets to get higher returns than from its European and U.S. assets, according to HSBC.
Qatar's $60 billion sovereign wealth fund, the Qatar Investment Authority, has cut its exposure to the dollar by more than half to around 40 percent of its portfolio. Qatar says it wants to invest in the customers of its energy exports.
"The U.S. is still the largest consumer of oil but the relative importance of the U.S. is declining because China and other emerging countries are creating new demand," said Giyas Gokkent, head of research at National Bank of Abu Dhabi.
"Eventually the status of the U.S. dollar as a reserve currency will be called into question."
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