Gulf state currency crisis: which way out of the morass?

• Author: Pinto, Luiz

After the beginning of the oil price crash of 2014-2015, member countries of the Gulf Cooperation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE) faced the longest period ever recorded of monthly consecutive losses in foreign exchange reserves. In 2015 and 2016, according to data from the International Monetary Fund, the GCC accumulated fiscal deficits of US$271 billion, current account deficits of US$64 billion, and foreign exchange reserve losses of US$201 billion. In this context, the sustainability of fixed exchange rate regimes in the GCC started to be questioned.

During this period, a number of other oil-exporting countries had to either float their currencies and depreciate (Russia, Kazakhstan, Azerbaijan, Nigeria, and South Sudan) or endure the consequences of "back door" floating because of the free fall of their currencies in parallel exchange rate markets (Venezuela and Angola). Moreover, twelve-month forward premiums in some USD/GCC exchange rates started to reflect market pricing of future devaluations.

Are the GCC countries going to follow suit with some of their OPEC fellows? Why? Is a round of GCC devaluations inevitable? Which GCC countries are more vulnerable?

To properly answer these questions, one should start by separating two different issues: the exchange rate regime and the particular price of certain currencies in relation to others. While the first topic is related to the more fundamental question of the macroeconomic policy framework and its responses to real and nominal shocks, the second is related to possible misalignments of exchange rates and the capacity of central banks to support a particular rate.

A closer look at the fundamentals of the GCC economies would still support the idea of fixed exchange rate regimes based on conventional pegs to the U.S. dollar as the optimal macroeconomic policy framework. The reasons are grounded in six main points:

* As small, open, oil-dominant economies in which the per capita petroleum production is very high, GCC countries tend to present large and structural fiscal and current account surpluses, accumulating sizable war chests and holding highly positive net international financial positions. The high level of savings can be used to withstand temporary deficits and avoid large recessionary adjustments.

* Real effective exchange rates are relatively stable because the elastic supply of low-wage expatriate workers from Asia in GCC labor markets restrains...