If I was to give you an opportunity to attend a presentation on corporate ethics hedging, it will take you a substantial amount of time to grasp the concept behind the presentation. This is because, ‘ethical investment’ has evolved and now it exists as an established term; it is now a phrase that trips off one’s tongue (www. goldnews. bullionvault. com 2007: 23-44).
However, I am somehow happy that it didn’t sound good to the concerned authorities when I read a suggestion on the journal giving an implicit direction like the route to an Enron-type result; because in the real sense, it meant that even if any company for example wanted to ‘hedge’ its ‘ethics’ no one anyone would proudly take the opportunity to advertise this type of service, even any well-known and reputable institution (www. goldnews. bullionvault. com 2007: 44-54).
Even during the presentation one will not clearly understand what is being said, and to the few, who understand, the name of the game that is being presented is known as corporate FX hedging, a well known name to an extent that even the central bank is talking about it. Basically the long awaited US dollar slide is likely to be underway and the main concern of the central bank is whether any business will be possible in an attempt to offer protection against such foreign-exchange risk exposure (Barber 2002: 6-12).
May be you are starting to wonder, but this is not even the most interesting bit of the Central bank’s recent research report, it is not even the most second interesting, but to it occurs to me as at least an attempt to forecast the falling of British pound and dollar in the course of the year against the UAE Dirham. That is to say that the idea of UAE dirham rising steadily against sterling makes the US Dollar equivalent earnings a less troubling problem to any British expatriate (Central Bank Survey 2000: 20-35)
Because the Saudi Riyal is pegged to the US Dollar, the Euro is 50% higher from five years ago to a record 5. 5 Saudi Riyals; this has increased the costs of import prices from Europe. This has led to more Federal Reserve rate cuts which are mainly designed to inflate the US money supply exerting an unbearable pressure on the Gulf currency pegs, as shown in the graph below. On an infinite bigger scale, this is the real issue behind any such kind of presentation and this is not only about the risk, but real returns to the Gulf countries as a whole.
According to standard chartered Bank, the proposed GCC single currency would de-peg from the US-Dollar, even the Dubai Chamber of committee and industry has thrown its support behind the standard chartered bank recommendations, suggesting that floating will allow independent policy making and enable them avoid the same fate as the US Dollar (Central Bank Survey 2000: 20-25)
Why the Dirham is pegged to the Dollar: however, if such kind of a decision was to be reached, it would be a confident bold step with significant implications, for example, the currency may be itself some way off, with rare rumors that its 2010 deadline is in doubt, but before they reach this amicable decision it is important for them to understand the timing factor for it is undoubtedly important if the problem is to be resolved here and how.
This is because such a bold step for this region is a radical step since it is a region whose currencies have for long time been mostly pegged to the US Dollar for decades (Central Bank Survey 2000: 26-30). Although, there has been no much trouble in doing so, it is now indeed appearing to be flourishing. Of most important to state here is that central bank’s well defined research, boils down to two easily accessible points,:-
(a) The best interest of the Gulf countries is to prevent their currencies from going down or sinking with the US dollar, this is when considering that, most exports are dollar-dominated imports and are substantially done in other currencies and this would in the end be more expensive. This is even enough to be understood leaving a side at the moment, the incendiary topic of whether oil should continue to be priced in dollars, and
(b) Secondly, is the issue of running domestic monetary policy in the line with the US policy, that is to say setting their interest rates parallel to the US Federal Reserve; experts warns that this will always run at a risk, because the policy stance is not appropriate whether too lax or too tight for local conditions.
According to them, the trade off between the confidence generated by the fixed relationship on one hand and the policy inflexibility on the other is its core conundrum, and there is also an increasing live issue when the interest rates seem considerably too low considering the Gulf’s rampant economies (Central Bank Survey 2000: 30-35) Pros and cons of a fixed peg: Matters relating to exchange rate policy are always a daunting assignment.
And this is especially so for a mere central bankers like the Asian countries, and further from even a small country and if the fringe of the recent dramas in Asia was something to boot. From then outset, in terms of avoiding crises arising from speculative attacks on currency, any free floating regime will seem optimal and any pegged exchange rate regime will be the most susceptible to crises (Kirsten 1999: 23-29). This is because the exchange rate can adjust very fast and even very smoothly to real shocks than is the real case in other regimes.
Secondly, and which is equally important to consider is that, in floating regime, domestic banks tend to hedge the currency risk of the foreign borrowing they undertake, and last but not least, in the case of exchange rate regimes, and this is where the central bank is committed to refrain from intervening in the foreign exchange market, there is a tendency of making big speculative plays which is even more difficult and considering that in such kind of situation, any speculator taking a big currency will be forced to find a way in some other private sector to cater for the other side, and this is even more difficult than almost guaranteed central bank intervention which provides the liquidity that will get it out of the speculative situation (Kirsten 1999: 30-40). In general, unless they are backed with strong political and institutional rules, like ones of a currency board of a complete dollarisation which is the only ultimate solution in irrevocable exchange rate fixing.
Broadly, that is to say a decision on currency union will be balanced between flexibility which will be afforded by the country’s own currency when compared to the possible microeconomic efficiency gains of this currency union, like the reduced transactions costs and exchange rate uncertainty with the partner country (Lyn 1996 22-33). Lastly, a fixed peg is susceptible to volatility and serious misalignment this is because free floating is the worst of all because of its own preferred option of a crawling band the best regime. Although short-term volatility is not of great concern, it also has a significant effect on trade, due to its easiness with which companies can hedge themselves against it (Lyn 1996: 34-39).
Why the peg hasn’t been an issue before: this can be well illustrated by referring to the period 200-2004, when the decline of the dollar against the euro increased the GCC’s import bill (Lyn 1996: 45-48). Currently, the dollar peg brings useful certainty vis-a-vis against the dollar, and when considering that the hydrocarbon sectors is still dominant, it implies that the impact of oil-price fluctuation is imported fully to the real economy, this means that some form of currency float will allow the exchange and interest rates to experience some strain (Lee 1999: 101-106). Why it is an issue now: all the same, there was subsequent decline against Asian currencies respectively, which was even projected to continue and this clearly represents a further ‘threat to the bottom line’.
This has a cleat implication that currency mismatch will also apply to budgets, and this is where revenues are also dollar-dominated although there is no frequent spending (Lee 1999: 106-111). Possible solutions; Nevertheless, forex diversification seems to become an increasingly important theme that is likely to go forward, globally. This means having 90 per cent and more of reserves in US Dollar, which used to be very impressive is no longer appropriate. This actually requires a couple of diplomatic euphemisms somewhere in there; that is to say if Asian Central banks, including Russia and others flee the dollar, it may be better to be with them instead of trying to hold so tightly to the fort (Kirsten 1999: 23-46).
According to the standard chartered bank “we believe the dollar is overvalued and therefore, could be subject to a significant correction”, and even though this forecasting appears cannily hedged itself, the warning is clear. I therefore, recommend that the planned GCC currency should be marked against a trade-weighted basket instead. ” (Central Bank Survey 2000: 20-35) On analyzing the above statement at a given level, it is compelling because of the main reason that the Gulf region is selling oil lucratively at $70 bearing in mind that the huge surplus is tied to the US dollar and with America in chronic deficit, it will make it buy it at the same expensive price, and therefore, this will eventually have a ring of absurdity about it, which is a very simple logical approach (Central Bank Survey 2000: 33-42).
Looking back, the IMF has suggested a more flexible rate policy will be more desirable when it considered that the GCC economies are becoming more diversified and integrated with world markets which has even called for dollar devaluation by saying “A trade-weighted basket peg would be no better than a dollar peg in procuring stability, and the flexibility versus credibility debate becomes no clearer, though a euro/dollar combination may offer a reasonable alternative. ” (Central Bank Survey 2000: 42-68) An economists, Emilie Rutledge, seems even more convinced he says that “As the GCC Economies are maturing and diversifying rapidly, the current inability to set their own monetary policy is far from optimal” and in addition “as a longer-term investment to the euro looks more promising than the dollar”.
This raises farther the creation of a single GCC currency as this will help reduce the pressure downwards on the dollar since these oil producing countries will in return invest more revenues gained at home instead of the previous investments in dollar assets (Barber 2002: 2-6). The common currency may even itself attain a reserve status in the end, if prices f oil were to be priced in the same terms. But the major obstacle will be “political disquiet” from the US in that; it is there main understatement or assumption. This means it should pause further for a thought (Barber 2002: 6-12). Recommendations It is possible for the GCC states to prejudice the value of their own existing reserves only if they acted effectively against the dollar, be it by diversifying their assets, depegging or pricing oil differently.
In fact in an environment of very high oil prices, it can be done without serious revaluation, but this may jeopardize any emerging non-oil activities and will eventually call for entirely inappropriate lower interest rates (Brealey & Kaplanis 1994: 43-57). And the issue of not pegging will risk the GCC tent of being blown about by a potentially storm- force wind. But standard chartered bank supports it suggesting that flexibility will be manageable, as this will be mainly the task of the concerned authorities to offset current inflows by capital outflows, and the only thing they will have to consider is whether the exchange rate or interest rate, which one will be given priority first (Brealey & Kaplanis 1994: 57-68).
Although de-pegging the GCC currencies will likely have a negative impact on the USD, due to the fact that the GCC countries do not have enough opportunities for investment domestically this will force make it absorb petrodollars, and this means they will continue to find their ways into the US treasuries even after a revaluation (Abraham, Bervaes, Guinotte, Lacroix, 1993: 23-32). According to Hany Genena, a senior Economist, EFG- Hermes “of course de-pegging would imply appreciation of all GCC currencies. In 2005, the combined current account surplus of the six GCC states is estimated at approximately $100 million with net foreign assets in the banking system (excluding reserves accumulated in stabilization funds) at approximately $260 to $300 billion”.
This is a positive outlook for crude oil prices over the medium term in addition to capital in flows and therefore all GCC states will have significant appreciation pressures on their currencies, this is a very important point to be noted (Abraham, Bervaes, Guinotte, Lacroix, 1993: 32-41). According to Simon Williams, Senior Economist, Economist Intelligence Unit “De-pegging does make sense (for the GCC), to run their own monetary policy. The inflationary situation at the moment throws that into a very sharp relief. A lot of preparation would need to be done, including stopping pricing oil in dollars. Otherwise it risks compounding the volatility of the local currency value of oil revenues (Abraham, Bervaes, Guinotte, Lacroix, 1993: 32-41).
The authorities would also have to guard very carefully against the kind of substantial appreciation pressures that there would undoubtedly be at the moment if the current were floating. ” But a standard Chartered Bank Head or research, Stare Brice says, “The key here is for the region to do what is the best for the long-term sustainability if the region’s economic performance, we believe that authorities still have time to diversity reserves quietly before the new single currency comes into effect. Forex reserves in fact are not the issue. The bigger issue is the investment agencies are clearly large even in a global context. They would likely be discreet in their diversification efforts. However, the impact on the value of the dollar would be there for all to see. ” (Abraham, Bervaes, Guinotte, Lacroix, 1993: 41-61)
Abraham, J.P., Bervaes, N., Guinotte, A. and Lacroix, Y. (1993). The Competitiveness of European International Financial Centres. Research Monograph in Banking and Finance M93/1. Institute of European Finance, Bangor; 23- 77
Brealey, R.A. and Kaplanis, E. (1994). In the journal ‘the Growth and Structure of International Banking’; City Research Project Report XI, London Business School; 43-68
Barber, T. (2002). In the journal ‘A tale of two complementary cities’. Financial Times 12 June, III. 2-12
Central Bank Survey (2002). Foreign Exchange and Derivatives Market Activity 1995, 2001 May, March. Basle: 20-68
Kirsten, B. (1999). The Future of European Financial Centers. Routledge, London; 23-46
Lee, B. (1999) ‘Countdown to harmonization’. Institutional Investor June: 101-112:
Lyn, B. (1996). Private Banking in Europe. Routledge, London; 22-66