Gulf currency regimes compared

One region, two arrangements 

The Gulf Cooperation Council has six member states and six currencies, and the exchange rate arrangements behind them are more uniform than almost any other regional grouping in the world. The United Arab Emirates dirham, the Saudi riyal, the Qatari riyal, the Bahraini dinar and the Omani rial are each held at a fixed published rate against the United States dollar. The Kuwaiti dinar is the exception: it is managed against an undisclosed weighted basket of currencies in which the dollar is understood to be the dominant component.

That single exception is why the group is worth comparing at all. Five arrangements produce a quote against the dollar that does not move outside its last decimal places. One produces a quote that moves a little, every day, without being a floating currency in any ordinary sense. The distinction between the two is the distinction between a fixed anchor and a fixed rule, and it changes what a quote can be read for.

What a single anchor arrangement does 

A conventional peg against one currency is maintained by a standing offer. The central bank deals with the licensed banks in its jurisdiction at the published rate or within a narrow published band around it, so no bank has a reason to deal materially away from it, and the market rate arrives at the official rate without the central bank having to transact on most days. Reserves fund the side of that offer that pays out anchor currency, and the domestic policy rate is kept close enough to the anchor's that holding one currency rather than the other does not pay for itself.

Two consequences follow for every one of the five. The observed movement of the currency against the anchor is close to nothing, so a spot chart of the pair is close to a horizontal line. And the currency inherits the anchor's movements against everything else in full, so a Gulf importer buying from Europe or Asia carries the dollar's trajectory whether or not any dollar appears in the transaction. A peg holds one rate, not all of them.

What a basket does differently 

A basket arrangement fixes the currency to a weighted average of several currencies rather than to one. The commitment is just as firm, but the thing committed to is itself moving: when the members of the basket move against each other, the average moves against each of them, so the managed currency moves against the dollar in small amounts even though nothing about the policy has changed. Movement against the dollar under a basket is the arrangement working, not the arrangement loosening.

The Kuwaiti basket's composition and weights are not published. That is a deliberate feature of the design rather than an omission: an undisclosed rule cannot be arbitraged precisely, and the central bank retains discretion it would give up by publishing. It also means nobody outside the institution can compute the arrangement exactly, so any weights used to illustrate the mechanism are an assumption and have to be labelled as one.

The final row is the part that is easy to miss. A basket managed currency is more stable than a floating one against every member of the basket and less stable than a pegged one against the largest member. It is not a halfway house between fixed and floating so much as a different objective: stability against a trade weighted average rather than against a single partner.

The monetary union that was not completed 

The uniformity of the arrangements above is not accidental. The Council pursued a single Gulf currency for many years, and the common dollar anchor was the convergence criterion that made the project arithmetically straightforward: currencies fixed to the same anchor are already fixed to each other. A monetary council was established in Riyadh to prepare the institutional groundwork.

The project stalled on the questions that monetary unions always stall on, which are political rather than technical. Oman withdrew from the timetable, and the United Arab Emirates withdrew after the seat of the future central bank was settled elsewhere. What survives is the common anchor without the common currency, which leaves the region in an unusual position: five of the six currencies are already fixed against one another by construction, and none of the institutional machinery that would make that permanent exists.

How the group reads as instruments 

• Five of the six produce a quote against the dollar with almost no observed movement, while the cost of dealing them does not fall to match. Cost and financing therefore dominate the arithmetic of holding them rather than sitting under it as deductions.
• The basket managed currency produces small daily movement against the dollar that is generated by the basket's other members rather than by anything happening in its own economy, so its chart is closer to a weighted average of other currencies' charts than to a story about itself.
• A Gulf currency cross against anything other than the dollar is arithmetic: the other currency's dollar rate multiplied by the fixed parity. All the variation comes from the dollar leg, so the cross carries no exposure the dollar pair did not already carry.
• Technical description of a fixed pair has very little to describe. Ranges, averages and breakouts are computed from price variation, and an administered price supplies almost none.
• Pressure on any of these arrangements is expressed in forward points and in domestic interbank rates, neither of which is fixed by the arrangement, rather than in the spot quote, which is.

Where practitioners disagree 

The first argument is whether a basket is better than a single anchor for a commodity exporting economy. The case for the basket is that it stabilises the currency against the trade weighted average of what the country actually buys, which is what determines imported inflation, rather than against one partner. The case for the single anchor is that it is transparent, cheap to defend and matched to the currency the exports are invoiced in, and that a rule nobody can verify is a rule that has to be taken on trust. The region currently runs both, which is as close to a controlled experiment as monetary policy ever gets.

The second argument is whether disclosure of a basket's weights would help or hurt. One tradition holds that a published rule is credible precisely because it can be checked, and that opacity invites participants to price a premium for the unknown. Another holds that a published rule invites positioning against the arrangement at its edges, and that discretion is worth more than transparency to an institution that has to defend a rate with finite reserves. Neither position has been settled empirically, because the currencies running each policy differ in too many other ways to compare cleanly.