Gulf News - 20/5/2006
The recent decision by Kuwait to appreciate the value of its dinar against the dollar is an understandable one. For the first time in 17 months, the authorities revalued the dinar by one per cent.
Prior to the adjustment, the Kuwaiti dinar was exchanged at 290 fils to the dollar. As such, one Kuwaiti dinar buys almost $3.5.
The move reflects growing concerns in Kuwait and elsewhere in the region about the adverse effects of the US dollar's continuing decline.
All GCC currencies are pegged to the US dollar, as part of a conservative policy. Amongst others, the link gives assurances of stability to investors in dealing with GCC countries.
Also, the link is essential in reaching the goal of establishing a monetary union with the introduction of a single currency within the six-nation group as early as 2010.
The currency peg results in the GCC states adopting interest rates prevailing in the US. In effect, regional states import ongoing interest rates in the US market, albeit with a positive differential to help attract business.
In other words, existing interest rates in Kuwait and elsewhere in the GCC reflect economic conditions in the US.
The Kuwaiti government partly attributed the currency revaluation to fears of importing inflation. This is related to the weakening of the US dollar against major currencies such as the euro and the yen.
The steady decline in dollar's value benefits the US by making American exports less costly and hence more attractive. The US suffers from an extraordinary trade deficit, a hefty $800 billion in 2005, a quarter of which is related to bilateral business with China.
Accordingly, the weakening of the dollar is meant to help correct the imbalance by making American goods cheaper abroad.
However, for Kuwait and other regional currencies, decline of the dollar makes imports not denominated in the US dollar only more expensive. The weakening of the dollar naturally reduces the value of Kuwaiti dinar versus other major currencies.
Hence, Kuwait had to pay more to acquire products from the European Union and Japan.
Business with Europe and Asia amounts to a sizable chunk of total Kuwaiti imports. This trend amounted to importing inflation. According to the Middle East Economic Digest (MEED), inflation rate stood at 3.5 per cent in Kuwait in 2005.
Kuwait enjoys an extraordinary trade surplus, thanks to firm oil prices. According to the MEED magazine, Kuwait's trade surplus amounted to $23.8 billion in 2005 on the back of exporting goods and services worth $37.9 billion.
Not surprisingly, Kuwait has come under pressure to deal with this gap. A paper by the US Treasury published in March noted that the trebling of oil prices since 2002 has boosted exporting potentials of oil-exporting nations such as Kuwait.
The paper urged oil-exporting countries to take serious steps to slow down exceptional surpluses in external accounts.
Aside from trade surplus, Kuwait likewise reported current account surplus of $19.2 billion in 2005, meaning that import of services could not offset the sharp rise in oil exports.
As such, the appreciation of the Kuwaiti dinar encourages trade by making imports less costly compared to the past. The move helps in containing inflationary pressures besides boosting activity in the local economy, thus benefiting growth of gross domestic product.
It is widely acknowledged that a 3.5 per cent margin on either side does not amount to end of currency peg.
This merely reflects adjustment to changing conditions. But the Kuwaiti move is a realistic one as it addresses inflationary fears besides helping contain surpluses in external accounts.