MANAMA: Bahrain's policy of pegging its currency to the US dollar is fuelling inflation and damaging investment, says a senior economist.The dinar's fixed relationship with a rapidly devaluing dollar is no longer to its advantage, says Bahrain Economic Society member Mohamed Habib Ali.
The policy is "neither controlling inflation nor protecting the external value of the dinar very well", says Mr Ali.
The solution, he told GDN yesterday, would be the use of a basket of currencies including the euro and others, as well as the dollar, to guide monetary policy across the GCC region.
"If it had benefits, they are gone," he says of the policy of pegging Gulf currencies solely to the dollar, in his latest research paper.
Mr Ali has a bachelor's degree and a master's in the field of economics, both gained at the University of Texas in the US.
He said that he was working on his next paper, which will tackle the controversial topic of inflation and will soon be available.
"The dollar has its own agenda and benefit for devaluating it, but the GCC's currencies are also devaluating by the same amount," he says in his current report.
"Are our agendas the same? Is the GCC going through the same economic cycle as the US?
"Are we benefiting from our currency also being devalued? To simply answer all of these questions, one has to look at many variables that make the GCC either better or worse off.
"Trade provides a good example. Apart from oil, the GCC nations are importing much more than they are exporting, therefore, if the imports are mainly non-dollars and are in other currencies, it must have a more negative affect.
"Ten per cent of GCC imports come from the US, but those from Europe and Asia each account for a third.
"In addition, two-thirds of the GCC's energy gets exported to Asia, thus, from a trade-weighted perspective, pegging exclusively to the dollar does not make much economic sense and the GCC should definitely diversify much more in its currency reserve basket.
"If the GCC is exporting its major commodity with dollars and only 10pc of its total imports come from the US, using those dollars, a further depreciating dollar will cause an unprecedented rise in prices of imports.
"In addition, we can purchase much less with the local currencies, causing real income and the standard of living to be much lower than what it really should be.
"What about GCC's main export oil? Politics and its pressures aside, looking at it from a trade-weighted perspective, Opec and the GCC both have to at least properly consider and study the pros and cons of exporting oil with a different currency other than the dollar.
"Apart from the negative effects, are we meeting the objective and the positive affects of pegging our currencies with the dollar?
"The Central Bank of Bahrain has the following objective: 'The exchange rate peg provides an anchor for monetary policy, which contributes to controlling inflation and protecting the external value of the Bahraini dinar.
'Low inflation and a stable currency are important long-term features of the Bahraini economy which support a stable business environment and high levels of investment, both of domestic and foreign origin'.
"Let us examine this: Is the peg an anchor for monetary policy? We adopt continuously deflating dollars, at a time where the US is facing a deficit, so do we need to also have a devalued currency, especially given the fact that we are running a surplus?
"We also adopt interest rates according to the US economic cycle, which is different than ours.
"A depreciating dollar and low interest rates fuel inflation by an amount still unknown, due to unfit tools for measuring inflation.
"If one looks at the GDP deflator for example - instead of the consumer price index which suggests a 2.6pc inflation rate (Bahrain, 2005) - one will see it suggests more than four times the amount. The GDP deflator is the difference between growth in nominal GDP and GDP if it were at constant prices.
"The bank of England has also suggested a 6pc inflation rate for Bahrain in 2006.
"As we can see today, the majority of people in the GCC are heavily feeling the rise in prices of their own basket of goods.
"Such high inflationary figures will normally tend to drive investment in wrong direction.
"This is because prices are rising at a higher rate than output is and therefore investments will shift their priority from productive ones that are based on output towards investments that are based on increasing their value.
"Price increases now become more of a reason to invest than output-based productive investments, saving rates will go down and people will invest more in economic activities that go up in monetary value, because interest rates on deposits are lower than inflation rates.
"But do those growing investments add a meaningful value and generate proper wealth, by advancing ourselves into a more productive economy? Or are we just merely trying to beat or keep up with inflation by any means possible?
"Inflation is curving up due to various factors, but where normally a stringently tightened monetary policy should play a role in taming inflation, adopting external interest rates and money supply policies is like adding fuel to fire.
"Therefore, according to the objectives of pegging to the dollar, we are presently neither controlling inflation nor protecting the external value of the dinar very well.
"These objectives were made to create a stable environment and improve both domestic and foreign investments.
"This has served its purpose well in the past, since individual GCC currencies will be vulnerable in currency markets, but looking at the way the dollar is heading, is it still going to maintain a stable business environment for the GCC?
"Logically, an alternative solution should be carefully considered and studied. But should the GCC adopt a policy of pegging of another currency, such as the euro?
"That currency is doing fine now, but the Europeans are also facing some economic problems and the long-term future is uncertain for any currency.
"Can our new unified currency be the answer? Is it going to be strong enough to survive vulnerability?
"Shouldn't the GCC export and import all its commodities via trading with its own currency and at the same time use its own monetary policy tool subject to its economic performance?
"These questions have now become increasingly more and more valuable."
