Gulf Arab central banks, faced with the prospect of having to match a possible near term US interest rate cut, agreed to develop separate policies to tackle rising inflation after failing to inject momentum into a plan for monetary union.
Regional central bankers met on Saturday to try to revive the single currency project, which was thrown into crisis in May when Kuwait dropped its peg to the sliding dollar to curb the inflationary effect of rising import costs.
The six Gulf oil producers agreed on Saturday that a 2010 deadline for creating single currency would be difficult to meet, Saudi Arabia's central bank governor said.
The central bankers are worried about rising inflation, which could hit 4 percent in Saudi Arabia this year, although they did not decide on any change to a policy of linking currencies to the dollar, Hamad Saud al-Sayyari said.
"Each member state will examine the possible options because the (inflation) levels are different across the region and the options are different," Sayyari told reporters after the meeting in Riyadh, the Saudi capital. Standard Chartered regional economist Steve Brice said markets would take Sayyari's remarks as a green light for the United Arab Emirates to revalue the dirham currency.
The governors did not discuss how they would respond if the US Federal Reserve cuts interest rates at its meeting on September 18, as markets expect. Any cut would put pressure on most Gulf central banks to follow to maintain the relative yield of their currencies.
"The governor may have been suggesting that Gulf responses to a cut by the Fed might be different," said Simon Williams, economist at HSBC in Dubai. "The downside of maintaining a dollar peg become ever more apparent when the economies of the Gulf and the US are at such different stages of the growth cycle," he said.
DOMESTIC INFLATION All six countries had agreed to keep their currencies pegged to the dollar until monetary union. Oman, Saudi Arabia, Qatar, the United Arab Emirates and Bahrain have repeatedly ruled out any change to foreign exchange policy.
"There is no change at the present time," Sayyari said. UAE central bank governor Sultan Nasser al-Suweidi declined to comment when asked whether he was considering changing the reference rate of the dirham currency.
The dirham, tipped by analysts in a Reuters poll in March as the most likely candidate for a revaluation after Kuwait's dinar, has been fixed at 3.67275 to the dollar since November 1997. "The UAE central bank governor has said the dirham weakness is a good thing and that he would not act unilaterally," said Giyas Gokkent, head of research at National Bank of Abu Dhabi.
"This might allow for a one-time currency revaluation but not a currency regime change," he said of the central bankers' plans to part ways on inflation policy. The six governors did agree that inflation was caused by government spending and investment flows rather than more costly imports, Sayyari said. "Inflation is one of the factors that represent a source of concern to all central banks," he said.
CURRENCY BASKET Inflation hit a seven-year high of 3.83 percent in Saudi Arabia in July, a two-and-a-half year high of 5.9 percent in Oman in June and 12.8 percent in Qatar at the end of the second quarter. Inflation was 9.3 percent in 2006 in the UAE.
In Kuwait inflation rose to 12-year highs in April and May, before falling to 4.36 percent in June, the first full-month that the dinar tracked a currency basket. Criteria agreed for creating a single currency include an inflation target of no more than 2 percent above the regional average. Inflation in Saudi Arabia, the region's lowest last year, could exceed 4 percent this year, Sayyari said. That would be the highest rate since 1995.
After reviewing "exceptional economic developments" the governors agreed that a 2010 deadline for monetary union would be difficult to achieve, he said. "There is agreement...on the difficulty of meeting the initial deadline," he said, adding it was too early to give a new timeframe.
The deadline has been in doubt since Oman opted last year not to join by 2010, saying the timetable was unrealistic and that it did not want to curtail spending to meet the budget deficit target.
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