International Herald Tribune
Gulf states remain wedded to dollar
By Landon Thomas Jr.
Monday, August 25, 2008
RIYADH: As oil prices soared and the value of the U.S. dollar plunged, a chorus of academics and policy experts took up the cry that Saudi Arabia and neighboring Gulf countries should abandon their currency peg to a depreciating dollar to help combat the social ravages of inflation that were spreading across the region.
The brief, put forth by the likes of Alan Greenspan and the Harvard economist Martin Feldstein, made impeccable theoretical sense: with Gulf economies riding an oil boom, higher interest rates and stronger currencies were needed, not the reverse. Currency traders took heed.
But that argument made only limited headway in Saudi Arabia. And now, with the dollar's modest comeback and oil's retreat, policy makers in the region have been bolstered in their resolve to keep the peg in place and accept the consequences of higher inflation if need be.
"The peg is here to stay, no ifs or buts," said Muhammad Al-Jasser, the vice governor of the central bank who oversees the financial management of Saudi Arabia's soaring dollar reserve base.
Sitting in his spacious office on the top floor of the Saudi Arabian Monetary Agency's postmodern headquarters, the academic in Al-Jasser - he has a doctorate in economics from the University of California, Riverside - relishes the to and fro of the debate.
But the policy maker in him takes a different view: the Saudi authorities have long said that a precipitous revaluation would increase investor uncertainty as well as shrink the government's budget surplus and its foreign exchange reserves. Plus, they say, it is not the exchange rate that is causing the price spiral.
"Inflation in our case and in this point of time is not a monetary phenomenon," Al-Jasser said during an interview last month. "It is driven more by government and private sector spending, coupled with the global boom in China and India. Wages are flexible here."
Flexible they may be, but that is cold comfort for millions of immigrant workers who swarm to countries throughout the Gulf - not just Saudi Arabia but the United Arab Emirates, Qatar and Kuwait as well - in search of a better life.
Consider Sher Bahader, a cab driver here in the nation's capital, who ticks off the items that have soared in price since inflation hit a 30-year high. Milk, food and, most acutely, rent.
"Too many things are expensive; its very, very difficult," said Bahader, 57, who works seven days a week from 4 in the morning to 11 at night to make enough to send to his five children and wife, who live in a small village in Pakistan-administered Kashmir. "If the oil price is high, that is good for the Saudi Arabian people, but not for the poor man."
The root of the problem is clear. Inflation is high and rising: 10.7 percent in Saudi Arabia as of April, up from 1 percent in 2003; 14 percent in Qatar for the first quarter of 2008; and 12 percent for the United Arab Emirates as of March.
But even as Gulf central bankers and outside prognosticators quarrel over how to respond to the situation, the intellectual divide between Gulf central bankers and outside prognosticators also highlights the gap that often exists between the prescriptions offered by academics and policy outfits in Washington, New York and Cambridge and the grittier realities that face policy makers in their home countries.
Indeed, academics are right when they say that the lower interest rates that dollar-pegged Gulf economies must adhere to have fueled a development boom that has resulted in major supply constraints.
In a part of the world that prizes stability of all kinds, however, it was always unlikely that countries like Abu Dhabi and Saudi Arabia would abruptly revalue and watch their budget surpluses disappear just to appease outside experts - or dyspeptic taxi drivers for that matter.
Especially when memories of oil at $10 a barrel and gaping budget deficits remain vivid.
"The Gulf countries have opted to inflate," said Brad Setser, an international financial analyst at the Council of Foreign Relations who was one of many arguing that the Gulf countries should forgo the dollar link. "If oil revenues are going up 500 percent you can afford to pay your workers more. But that will just add to the inflationary spiral."
It is not just the academics either: the world's credit ratings agencies have recently warned that higher inflation in the coming years could lead to social unrest in the region even as the agencies themselves conclude that the large internal and external surpluses rule out a downgrade.
And on Aug. 11, the International Monetary Fund said that over time, if inflation persisted, Saudi Arabia should consider tying the riyal to a broader basket of currencies, as Kuwait has done.
Because they are paid in riyals and dirhams and then convert them back into dollars to send their wages home, foreign workers, who are estimated to comprise 50 percent or more of the work force in Gulf countries, have felt the punishing brunt of the dollar's slide.
Pay has increased for many imported workers, but it is not enough to compensate for rising food prices and, even more important, the soaring monthly rent, which accounts for 25 percent of the inflation index.
That creates something of a Catch-22 for local governments: to reduce housing costs, they must slake their thirst for inexpensive foreign labor. But that will hinder the region's planners in accomplishing the ambitious development projects intended to provide economic stability and employment opportunities for currently underemployed nationals, whatever the price of oil.
Such a quandary means little to Mahmood Gabar, a 36-year-old taxi driver from Egypt who, carrying only a high school diploma, was drawn to Abu Dhabi 15 years ago by the prospect of robust wages and permanent work. For years he made enough to enjoy a young man's life in the emirates and send more than enough back to his family in Cairo.
But over the past five years, the cost of renting the cramped 7-square-meter, or 72-square-foot, room he shares with two other workers shot up from 800 dirhams a month to 3,000, leaving him little to send home to his wife and newborn daughter.
"I won't stay here anymore," he said, his voice rising in frustration. "I am in the emirates 15 years and I have nothing."