GCC facing dilemma as dollar falls

Soaring oil revenues have taken the foreign exchange reserves of GCC countries to a whopping $1.6 trillion beating China’s $1.33 trillion.

With crude prices expected to rise further the six GCC nations could soon see their FX reserves bulging to $3 trillion. The challenge now is what to do with the reserves.
Traditionally the GCC and the majority of nations in the world have been using a large part of their reserves to buy dollars or invest in US Treasury bills.
Central banks worldwide, which hold about $5 trillion in total reserves, are increasingly important players in the $2.5-trillion-a-day FX market.
But with the dollar losing its charm as a reserve currency due to its persistent weakness against the euro and a number of other international currencies, countries are now diversifying their dollar-denominated assets.
For a start GCC countries can look at China. What is it going to do with $1.33 trillion of foreign exchange reserves? Speculation is rife that China may invest $3 billion in Blackstone, a US private equity company.
Although it has risks the measure could increase the low yield that countries currently get on their FX reserves. Economists say if countries invested a modest proportion of their FX reserves in global equities instead of gilts, their increased return may be one per cent of GDP.
Countries are creating new investment companies that—-unlike central banks—have the expertise to divert part of FX reserves into equity, real estate and hedge funds. Singapore, Korea, Qatar and Abu Dhabi are examples. India is going to follow suit.
China has created the State Investment Company, (SIC), which will invest $200 billion of the country’s FX stash, into publicly listed companies, real estate, or private deals around the globe. Mostly likely, at the bottom of the list of possible Chinese investments are US Treasury bonds, which are a losing proposition due to heavy pressure for a further slide of the US dollar against the yuan. India is investing part of its FX reserves on infrastructure development.
The IMF estimates that annual current account surpluses could rise above $300 billion as long as crude oil prices average $60 a barrel. For the GCC, the easiest way out is to move reserves out of dollar and buy euro or euro-denominated assets. The UAE has already moved ahead with its decision to shift at least 10 per cent of its assets to euro. Kuwait has thrown out the dollar peg and revalued its currency.
The issue of central banks shifting out of dollars has long been a problem for the greenback. Earlier the Fed had been aggressive and hiking US interest rates rapidly making the cost of shifting out of dollars high. However, when the US brought a halt to its rate hike series in June 2006 the debate of FX shift started again.
States like Bahrain, Oman and Dubai that do not have massive oil reserves are seeking to base future development on services, notably finance and tourism.
Bahrain, which has over $3 billion in FX reserves, has been maintaining that it had no plans to diversify its foreign exchange reserves. The Bahrain central bank has repeatedly said it does not plan to shift more of its largely dollar-denominated reserves into euros, although some other Gulf central banks are looking to diversify their holdings.
But the country needs to make best use of its current account surpluses for creating a good infrastructure and building up its knowledge economy.
Last week the dollar fell to a record low against the euro and the weakest in 26 years versus the pound on speculation declining consumer spending will weaken the economy and dim the allure of US assets.
The dollar fell 1.1 per cent last week to $1.3782 per euro and reached $1.3814 per euro by Friday, the lowest since the European currency’s debut in January 1999. The US currency declined 1.2 per cent to $2.0343 per pound and touched $2.0367, the weakest since June 1981.
If the trend continues and euro hits $1.40, even dollar-committed nations could be forced to diversify away from the greenback, leading the US currency to spiral even lower.

Talking Business
K S Sreekumar
sreekumar@tradearabia.net