Gulf Arabs could drop dollar pegs in unison

By Daliah Merzaban - Analysis

DUBAI (Reuters) - Gulf Arab oil producers, torn between rising inflation and exchange rates fixed to a sliding dollar, could consider switching together to a currency basket to buy time for a troubled monetary union project.

A region-wide shift could catch investors unawares after months of market speculation that the United Arab Emirates or Qatar would break ranks with their neighbors and unshackle their currencies from the dollar as Kuwait did this year.

So far, most bets on currency appreciation have focused on signs that Gulf states are drifting apart after Oman chose not to join monetary union by 2010, Kuwait switched to a currency basket in May and a U.S. rate cut divided central banks in the world's top oil-exporting region.

But signals from the banks and growing pressure on Saudi Arabia to tackle inflation suggest markets waiting for one country to revalue may be barking up the wrong tree.

"I think they will stick to multilateralism," said Marios Maratheftis, regional head of research at Standard Chartered Bank.

"They have been hinting at a more flexible option to the dollar peg. The debate is on, at a multilateral level," he said.

That is not the view of most analysts. Thirteen of the 17 economists polled by Reuters last month tipped the UAE as the top candidate for a unilaterally change in currency policy, with 11 saying a revaluation was likely by the end of 2008. For poll summary click on ID:nL12723561

CLOSING RANKS

Yet UAE Central Bank Governor Sultan Nasser al-Suweidi has always said he would not act alone, even while calling for a regional review of exchange rates in January. "We have to decide on a pan-Gulf basis," he told .Commerce magazine this month.

Suweidi and his counterparts have closed ranks since Kuwait threw plans for monetary union into disarray by abandoning a dollar peg the six states had agreed would stay in place until they created single currency in 2010.

"Credibility is quite serious for central bankers," said John Sfakianakis, chief economist at SABB bank, the Saudi affiliate of HSBC. "The likelihood of moving in unison is greater than the likelihood of moving alone."

Kuwait said the dollar's slide to record lows was driving up inflation by making imports more expensive. It also cited delays to monetary union as reason for scrapping the dollar peg.

With all six countries agreeing the 2010 deadline is difficult, if not impossible to meet, investors have been waiting for one or more of Kuwait's neighbors to follow its lead.

But markets watching for a widening rift over currency policy got nothing from a weekend meeting of finance ministers and central bankers.

"There was agreement that there is no need to change the current foreign exchange policy with consensus of all member states," Saudi Governor Hamad Saud al-Sayyari said after the talks.