Ending dollar peg won't solve Gulf inflation: Paulson

ABU DHABI Sun Jun 1, 2008 11:18am EDT

U.S. Treasury Secretary Henry Paulson speaks during a news conference in Jeddah May 31, 2008. Paulson said on Saturday the dollar peg for currencies in the Gulf Arab countries had served the region well and any changes to the peg would be a sovereign matter. REUTERS/Suzan Baaghil

U.S. Treasury Secretary Henry Paulson speaks during a news conference in Jeddah May 31, 2008. Paulson said on Saturday the dollar peg for currencies in the Gulf Arab countries had served the region well and any changes to the peg would be a sovereign matter.

Credit: Reuters/Suzan Baaghil

ABU DHABI (Reuters) - Treasury Secretary Henry Paulson said on Sunday leaders of Gulf oil producing states had told him that abandoning their currency pegs to the dollar will not solve their inflation problems.

Paulson, two-thirds of the way through a four-day trip to Saudi Arabia, Qatar and the United Arab Emirates, said leaders in the region have "quite an awareness that the peg does not influence inflation to a significant degree.

"They recognize that inflation is the overriding issue ... Ending the peg is not the solution to the inflation problem."

However Paulson said he could not rule out any moves by Gulf states to abandon the peg, reiterating his view that currency policy decisions were sovereign matters.

Five of the six Gulf oil producers -- except for Kuwait -- peg their currencies to the dollar, which means that they must match U.S. Federal Reserve interest rate cuts even as their economies surge on record high oil prices.

Some in the region argue that this and the dollar's decline in recent months is fuelling inflation, which might be better controlled by pegging to a basket of currencies.

An economic adviser to Qatar's ruler has said the Gulf state needs to drop its peg to the dollar because its economy is surging while the U.S. economy is slowing, London-based MEED reported on late on Friday.

"We have to delink," MEED quoted Ibrahim al-Ibrahim as saying. "It does not make sense to stay linked to a currency that is declining while our economy is growing ... at a time when our currency should be going up, it is going down."

At 13.74 percent, Qatar's inflation was the highest recorded among Arab countries in the Gulf last year.

But Paulson, in talks with officials including Saudi Arabia's King Abdullah, Qatar's prime minister and finance ministers from the two states, said earlier in Doha he has yet to hear a leader blame the peg as the chief cause of inflation.

INFLATION SOURCES

Instead, Paulson said, officials in the region cited high prices for food, construction materials such as cement and other key commodities were the primary sources of inflation.

He said they cited Kuwait as a country which is still struggling with high inflation despite its abandonment of a dollar peg last year.

Oil producers in the Gulf region have a long term goal to achieve monetary union and more countries abandoning dollar pegs could hamper those efforts.

Paulson also repeated his view that a strong dollar was in the United States' interest and that the greenback's value would ultimately reflect strong longer-term economic fundamentals.

Paulson also said he believed rapidly growing sovereign wealth funds were mainly seeking returns on their investment rather than pursuing political goals on behalf of their governments.

But he said adoption of "best practice" guidelines by the government-run funds would help allay protectionist fears.

"We're not picking on sovereign wealth funds", Paulson said, noting best practices under development by the International Monetary Fund were "a good way to inoculate ourselves against protectionist sentiment around the world".

The most important of these guidelines would be those for governance on how investment decisions are made, and who makes them. Independence in this area will help identify sovereign wealth funds as "investment pools being driven by economic and commercial objectives."

Qatari Prime Minister Sheikh Hamad bin Jassim al-Thani is chairman of the Qatar Investment Authority, which manages about $60 billion of assets, according to Standard Chartered Plc.

Abu Dhabi, along with Singapore, has already signed up to a U.S. Treasury-devised set of best practice guidelines.

Paulson also said he has received indications of interest for investments from the Gulf region in a new clean technology fund supported by the United States, Britain and Japan.

The multibillion dollar fund aims to subsidize projects in developing economies such as power plants using the lowest carbon-emissions producing technologies commercially available. It would achieve this by bridging the cost gap between new technologies and older, cheaper technology that is dirtier.

(Editing by David Holmes)

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