With sufficient access to foreign currency assets, external financial support and able to meet pressures on their exchange rates, GCC sovereigns’ pegged exchange rates are likely to remain in place, S&P Global said yesterday.
The rating agency said it expects that GCC sovereigns would use their liquid external assets to support their economies in times of financial distress, including in defense of their currency pegs, citing a recent example from Qatar.
When some Arab countries imposed a blockade on Qatar, outflows of non-resident funding from Qatari banks totaled $22bn in 2017.However, an injection of $43bn by the government and its related entities--mostly the Qatar Investment Authority--more than compensated for the outflows, the rating agency said. “We believe that GCC sovereigns can maintain their pegged exchange rates because we view all of them as having sufficient access to foreign currency assets, or external financial support, to meet pressures on their exchange rates,” said S&P Global Ratings credit analyst Trevor Cullinan.
“Although we view the GCC pegged exchange rate regimes as supportive of sovereign ratings in the region, there is necessarily a trade-off against the benefits of more flexible arrangements,” Cullinan added.
In terms of reserve adequacy, Kuwait shows clear strength in terms of the availability of reserves to cover the monetary base and current account payments over the next four years. Qatar and other two sovereigns also show significant strength. Importantly, in terms of reducing pressures on GCC exchange rate pegs, S&P expects oil prices to recover in 2021, with Brent averaging $50 during the year, up from $30 in 2020.
This will provide a 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. However, for most of the GCC countries, S&P’s 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.
Under the same framework, external pressures should be more muted across the GCC, with only Bahrain and Oman’s IMF external breakeven oil price above our assumption of $50.
The rating agency noted that the fixed exchange rates have worked well for the GCC through various oil price peaks and troughs. This reflects the reality that energy production (a dollarized industry) makes up a sizable share of gross value added in the region.
Given the dollar-based nature of GCC economies, the pegs have provided a nominal anchor for inflation, supporting monetary policy credibility by outsourcing it to the US Federal Reserve. However, adopting US monetary policy can also bring challenges because at times interest rate settings may not be supportive of nonoil output growth in the GCC. Moreover, economic theory suggests that a flexible exchange rate allows a currency to act as a shock absorber during balance-of-payments crises and increases monetary policy flexibility, via the interest rate channel.
A floating exchange rate can provide a shock absorber for small open economies facing external shocks, by boosting exports and supporting domestic demand and output. The rating agency noted that currency devaluation would increase the local currency value of US dollar-priced oil- and gas-related revenues.
