The sliding dollar may spur inflation in energy-rich Gulf states whose currencies are pegged to the greenback, but the exchange regime peg will survive for now, analysts said on Sunday.
As the dollar continues to lose ground to other world currencies, the six-nation Gulf Cooperation Council (GCC) states are bound to pay a higher price for their imports from Europe and southeast Asia, they added.
GCC economies, hard hit by the global economic crisis, are forecast to return to strong growth next year thanks to higher oil revenues, thus feeding higher inflation, but it will not return to last year's levels, the analysts believe.
"The clearest consequence of a weak dollar (on GCC) would be through higher prices for imported products," Paul Gamble, head of research at Saudi Jadwa Investment, said.
"This will not necessarily translate immediately into higher inflation, as there is a lot of slack within the global and local economies that is keeping inflation under control," Gamble told said.
"Nonetheless, a persistent downtrend in the dollar will eventually feed into inflation and this could be exacerbated by higher commodity prices, as commodities are being used as a hedge against dollar weakness," he added.
Since March, the US currency has lost by around 18 percent to the euro and experts predict the dollar's weakness will be long term. Oil prices have surged by more than 75 percent since sliding to 34 dollars a barrel early this year.
Kuwait pegs its dinar to a basket of currencies, but the dollar has a weighting of more than half, forcing the dinar to drop in value against other major currencies.
Other GCC members, oil powerhouse Saudi Arabia, United Arab Emirates, Qatar, Oman and Bahrain, have seen their currencies slide more against the euro and yen because of the total peg to the dollar.
GCC states buy the bulk of their imports from Europe and southeast Asia and as such have to foot a bigger bill for these purchases.
The most marked impact of the tumbling dollar on GCC countries will be a steep rise in food prices, says Amrith Mukkamala, senior financial analyst at Kuwait Financial Centre (Markaz).
"We assume that the dollar slide is long-term... Weaker dollar gives an additional price to imports and it specifically impacts food prices," Mukkamala said.
"It will give rise to imported inflation. Inflation is already picking up in GCC states and we expect to see a persistent trend of high inflation in December," he said.
But it is very unlikely that inflation will return to record-breaking levels of 2008 when the rate reached double digits in five of the GCC states, he said. Tiny Bahrain was the only exception.
Average inflation in the six GCC states is forecast to end 2009 at 2.9 percent, down from 10.8 percent last year. But the rate will pick up in 2010, supported by high oil returns and faster economic growth, Mukkamala said.
High inflation in the past two years triggered debate over whether the GCC states should keep the dollar peg, especially after the sharp divergence in US and Gulf economies.
"We expect that US interest rates are likely to remain very low for a sustained period and as the GCC economies pick up, a disparity between interest rates in the US and those required by the GCC will again appear," Gamble said. "If this is accompanied by rising inflation stemming from a weaker dollar then further discussions about the appropriateness of the exchange rate peg are likely," he added.
Most GCC states, spearheaded by Saudi Arabia, shrugged off calls to end their association with the dollar when inflation skyrocketted, saying the cost of de-pegging would outweigh the consequences of sticking to the current exchange rate regime.
Mukkamala believes it is premature to forecast any discussion of the dollar peg system, especially as the proposed GCC single currency is expected to be pegged to the dollar.
Bank of America Merrill Lynch said in its latest quarterly report that there is no danger to the GCC dollar peg next year because depreciation in the value of currencies is being compensated by high oil prices.
"We do not foresee change in the exchange rate regime in the region and a break of the dollar peg ... On this basis, we forecast a flat line for all the major GCC currencies until end-2010," the bank said.
Most Gulf states are predicted to post a budget surplus this year after projecting huge deficits by assuming very low oil prices in calculations of oil revenues.
Kuwait to post 24 billion-dollar budget surplus