Gulf countries, facing wider fiscal deficits amid low oil prices, are unlikely to devaluate their currencies even though defending their dollar pegs may lead to a depletion of foreign assets and debt accumulation, ratings agency Fitch said.
Currency pegs fix the value of one currency relative to another and central bank reserves are crucial to enforce that relationship.
Policymakers in the petroleum exporting region have long said that dollar pegs serve their hydrocarbon-heavy economies, but this year’s drop in oil prices has increased strains on a number of pegged currencies.
Saudi Arabia, Kuwait, UAE and Qatar have sufficient resources to maintain their peg regimes, Fitch said, while external financial support remains critical for Bahrain, which was pledged $10 billion from its wealthier Gulf allies in 2018 to avoid a credit crunch.
In the case of Oman, which has higher foreign reserves than Bahrain, buffers are eroding quickly and upcoming large debt repayments may undermine confidence in the peg.
Gulf states have been cutting and reallocating expenditure this year, and Saudi Arabia — the region’s largest economy — has increased a value-added tax to boost revenues.
Fixing their finances through fiscal consolidation rather than by devaluating their currencies is consistent with the structure of Gulf economies, Fitch said.
“Devaluation would result in few competitiveness benefits to GCC countries given the undiversified nature of their economies,” it said.
Social concerns are also likely to discourage governments from currency devaluations, as they may lead to increases in cost of living.
“Potential social backlash is a risk both of devaluation and fiscal consolidation, although fiscal policy may lend itself better to a more gradual adjustment,” said Fitch.