Gulf states 'must break dollar link'

Abu Dhabi: It is time for Gulf states to break free from the declining dollar to stop rising inflation, The Economist has said.

The London-based magazine warned in a report published last Thursday that the dollar's relentless decline against major currencies was "prompting jibes from America's critics, jangling investors' nerves and giving policymakers headaches."

It urged the Gulf states to "loosen their ties to the dollar" when their leaders meet on December 3 in Qatar.

"Nowhere are the dilemmas more acute than in the Gulf, where virtually all the oil-rich states peg their currencies to the greenback. The combination of soaring oil prices and the tumbling dollar is distorting their economies and fuelling inflation," the magazine said.

"The argument for linking to the greenback was to provide an anchor for the region's economies, many of which are small, open and financially immature. In effect, the Gulf states import America's monetary policy. The trouble is that a fixed currency makes it hard for oil exporters to adjust to swings in the price of oil. And monetary policy in the world's largest oil-importer is not always right for those who sell the stuff."

It added that soaring oil prices have brought the Gulf huge riches. Their real exchange rates, as a result, ought to rise. The simplest way to do that is for the currency to strengthen, but the peg prevents nominal appreciation.

Worse, the dollar itself has been falling. The result is rising domestic inflation.

The report suggested including the oil price as part of a basket that includes the leading currencies. "This would ensure their currencies absorbed some of the impact of oil-price swings."

It also voiced fear that ending the dollar peg may cause panic among investors. "The worry is that the end of the Gulf states' dollar peg would send jittery investors into a panic. That risk is real. But with oil prices rising and the dollar falling, the dangers of inaction are greater."