from Follow the Money

Saudi riyal, Kuwait dinar, UAE dirham hit multi-year lows v. the pound …

April 17, 2007

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They are also getting close to a record low v. the euro

Yet oil is, well, still rather strong.   Against the dollar.  But also against the pound and euro.   The euro and pound have gained significantly on the dollar over the past few years, but oil has gained even more. 

A little while back I noted that the impact of China's depreciation against the euro (really Asia's depreciation against the euro, as most of Asia still tracks the dollar and the yen is rather weak) on trade and investment flows was an under-reported story (That may be changing: see Keith Bradsher's new story in the New York Times).   

I also suspect the impact of inappropriate currency pegs – like the de facto currency union between the world's biggest oil importer and the world's biggest oil exporter – is an under-reported story. 

Inflation is now rising throughout the Gulf.  Quite significantly in some places.   A weaker dollar (riyal, dinar, dirham) is the last thing the Gulf countries need now that they are really starting to spend their oil windfall.   

The Kuwaitis seem to get this – even if they are (perhaps) constrained by the GCC’s commitment to peg to the dollar in advance of their planned (but increasingly unlikely) currency union.  The Saudis, well, not so much. 

John Sfakianakis of the Saudi Arabian British Bank just issued a long report arguing against a revaluation (hat tip, Mikka Pineda).  A key argument: imported inflation from the dollar’s 12.5% slide v. the euro can not possibly explain a 40% increase in retail prices.   (40%!)    And since imported inflation is overstated, so too is the case for a revaluation.   John Gamble of SAMBA -- another Saudi Bank -- went through the full range of possible inflation fighting tools in a recent report.  He though rather cursorily dismissed a revaluation on the grounds that its wide ranging economic impact made it an inappropriate tool. 

I wasn’t convinced.    The dollar’s slide may not explain the rise Saudi inflation – which likely reflects a fall in “fiscal” sterilization as the Saudis have started to spend more of the windfall from the rise in oil prices.   As more of the oil windfall converted into riyal and spent locally, money growth has picked up (Saudi m3 growth was close to 20% in 2006).  That is the core reason for the pick-up in inflation.

But a weaker dollar certainly didn’t help.   And the wide-ranging economic impact of a revaluation is precisely why it is an effective inflation-fighting tool. 

The details reported in the Sfakianakis paper left me more convinced that the Saudi data – which shows a 3.5% y/y increase in prices – understates actual inflation. Some tidbits:

  • The price of a schawarma sandwich is up 30% in the last 18 months.
  • Fresh fruit prices are up between 50 and 80% (y/y), and vegetable prices are up 20-40%, according to an informal survey.  It seems that higher paying construction jobs are pulling imported labor out of agriculture (cement factories are at 100% of capacity).
  • Beef prices are up 15%, Fish prices are up 20-35% (all y/y).
  • Rents in Riyadh are up 20-25% y/y
  • Wages for high-end construction jobs are up 50% -- and Saudi contractors are complaining of a shortage of imported labor at the low-end. 

All in all, that doesn’t sound to me like an economy with 3.5% inflation, even if the price of a telephone call is falling.  A cut in fuel prices (yes, a cut -- nothing like sitting on a big pool of oil) in 2006 did help hold down 2006 inflation, but no further cuts are expected in 2007 ...

According to the official data, the Saudi Riyal depreciated 20% in real terms from 2002 through 2005.    The riyal even depreciated in real terms against the dollar – if you believe the data – as Saudi inflation was well under 1% a year during this period (SAMBA has the details), while US inflation was a lot higher.

I don’t believe the data.    I suspect inflation was a bit higher in 2005 than reported – and a lot higher than reported in 2006, so the overall real depreciation is a lot smaller.   And inflationary pressures have not disappeared. 

Especially not if the Saudis insist on following the dollar down.

It would be kind of ironic if the dollar’s weakness – which at a minimum is adding to inflationary pressures in the Gulf – reflects petro-states shifting their investment portfolios toward euros and pounds.   I don’t have a clue what SAMA (the Saudi Arabian Monetary Agency) is doing with its $200b plus of foreign assets, but some data Rachel Ziemba and I have pulled together suggests that the big Gulf investment funds do have a relatively low dollar share in their portfolio.   

And we know the Russians have been shifting funds toward the euro and the pound.  But the Russians peg to a basket – not just to the dollar! 

Then again, I suspect some market analysts confuse the ongoing dollar sales oil funds – and central banks – need to make in order to keep the dollar share of their portfolio from rising (the oil states get paid in dollars, most central banks intervene in dollars) with diversification.   There is a difference.  Diversification means lowering your dollar share, not selling just enough of all the new dollars coming in to keep the dollar share of your portfolio from rising.   

And the way dollars are flowing into central banks (the Russia's reserves rose by $7.6b in the first week in April), they have to sell a few dollars just to maintain their existing currency split. 

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