Expatriates in the GCC have been enjoying higher exchange rates since news of the Irish bailout broke out. But this benefit may take a toll on oil prices and consequently threaten the region’s economic growth.
The inevitable consequence of pressure on the euro is a stronger dollar, a trend that may be further amplified by the greenback’s recurrent safe-haven status at times of exceptional stress, NCB Capital says.
The pressure is fuelled by Ireland, which has become the second Euro-zone country to accept a bailout (80-90bn euros) from the European Union after Greece. But this crisis differs from its Greek predecessor both in its origin and triggers.
While Greece was burdened by unsustainable levels of government debt Ireland has built up excessive leverage levels in the private sector, in large part due to the country’s extraordinary housing boom. The banking crisis has given Ireland a 32 per cent of GDP deficit, which threatens to push up its debt-to-GDP ratio to the triple digits from only 12 per cent in 2007.
“For the GCC region where inflationary pressures have once again been trending up, this should provide at least some temporary relief,” Jarmo Kotilaine, NCB Capital chief economist, says.
Bloomberg figures show the dollar gained the most since August against six major counterparts as concern that Europe’s debt problem will worsen and military action in Korea will escalate boosted demand for the US currency as a refuge.
The Dollar Index has been rising from November 4 (75.88) and ended up 80.36 on Nov 26. The euro, on the other hand, tumbled 3.2 per cent to $1.3242, from $1.3673 Nov. 19. The three-week decline was its longest since May. The greenback rose 0.7 per cent against the yen to 84.10, from 83.55 yen, its fourth weekly gain.
This means GCC currencies – which are either pegged to US dollar (with the exception of the Kuwaiti Dinar that is pegged to an undisclosed basket largely dominated by US dollar) – can buy more foreign currencies. Companies can purchase more imported products and services, and the value of every dirham or riyal sent by expatriates is increased.
However, this is a benefit brought at a cost, Kotilaine warns.
Because as much as the oil market has shown considerable resilience during much of the global crisis, a major relapse in Europe would sour the mood again, even if price declines were to prove temporary and moderate.
A weak dollar has had some positive effects already in the region’s economy. Bank of America Merrill Lynch Global Research says Dubai is best positioned to benefit from dollar weakness thanks to its service-based economy.
As per BofAML analysis, a weak dollar (caused by quantitative easing) will push oil prices up. The report goes to say that as the effects of quantitative easing – higher asset values and lower interest rates – happen, oil prices will likely touch $100 per barrel next year.
“The immediate impact of the unfolding drama in Europe has been another period of heightened market uncertainty,” Kotilaine said. “The GCC’s private sector recovery will be tested but should continue to benefit from the US quantitative easing.”