Revaluation of local currencies may be more likely than a single currency

Perhaps it should not be surprising that after the Third Great Oil Boom the GCC states are bound to look at whether the peg to the US dollar is set at the correct rate.

A study from the Dubai Chamber of Commerce and Industry this week used The Economist's famous Big Mac PPP index to establish whether GCC currencies were over or under valued relative to the US dollar. This index compares the price of a MacDonald's hamburger as an indicator of currency valuations.

The least undervalued currency on this ranking was the UAE at -12 per cent, while Kuwait and Oman scored -16 per cent, Qatar -20 per cent, Saudi Arabia -23 per cent and Bahrain -27 per cent.

UAE dirham

The DCCI admits that this is not a precise forecasting tool as the model has its limitations. And the obvious conclusion is that the UAE's dirham is the regional currency least in need of revaluation.

What has happened to the GCC currencies is that the 40 per cent devaluation of the US dollar over the past five years conflicts with a surge in oil exports and the requirement for huge imports from Europe priced in euros, distorting the valuations of local currencies and causing inflation.

Thus perhaps a coordinated adjustment of currency values by the GCC central banks ought to be considered, quite apart from any consideration of a single currency. Indeed, such a re-alignment could also serve as a way of converging currency values for a monetary union.

Practical implications

However, this would come as something of a shock to a trading and investment community not used to changes in currency valuations vis-a-vis the US dollar. Basically everything valued in local currency then becomes more valuable, and everything held in dollars less valuable in local money.

So to protect against revaluation you should hold more local currency and minimize US dollar transactions. And buying assets in GCC countries at today's US dollar value would make for a good investment - as you will benefit from a one-off upward re-valuation.

For local investors overseas buying in Europe would become cheaper. And there would be a one-off lowering of consumer price inflation due to the impact on euro-denominated imports which dominate the consumer sector of the economy.

But it will take a lot more than a Big Mac index result to convince GCC central bankers that a revaluation against the US dollar should occur.

Yet the fact remains that the US dollar's recent devaluation in no way reflects the buoyancy of the GCC economies and could be corrected by an adjustment to the currency peg.