Limited Options
By Shankar Kailasam, Vice President (Research), Gulf Investment Services

How do you control prices? For me, except for Saudi Arabia, which fixes prices at the port level, none of the other governments do. So, when you talk about free market pricing and you talk about key trade agreements being signed, there is no way you can control prices.

In the current situation, when the economy is doing pretty well and the spending power had increased significantly, obviously the demand will be significantly higher. So there is no way that you can control inflation. Yes, you can control the inflation through rent-sealing measures, etc. Other than that, you can’t do anything with the other sectors because internationally the commodity prices have increased. So everybody will justify in terms of price rise in retail segment. So, it is a pass through from all ends. Take bread for that matter. None of the flour producers/bakers can bear the costs because it has increased by 70 to 80 per cent. It has to be passed to the customer as no baker will bear the cost and the government can’t do anything. They can’t even give subsidies because of all these trade agreements.

The CBO chief also says that it is a passing phase. Now that there is 15 per cent cap on rents and a couple of other things, they reckon that they will be able to rein in the price level. By taking care of these two, do you really reckon that they will be able to avoid revaluing the RO-USD parity?

So, from the economic point of view, if you ask me it is very difficult to manage the current volatile scenario. If you ask me politically, probably they know much better and it will be difficult for them to do it. The other aspect is that you have a trade situation where trade is dollar-denominated. And even though dollar pricing has been done, the countries that are exporting goods to Oman have experienced a significant appreciation of their respective currencies. With this sort of trade structure, you will import inflation. And this is beyond control. So eventually your currency is depreciating because of your peg with the US Dollar. Further, if you are not going to adjust your interest rates (which is the case with Oman), then you ultimately revalue. Trying to stick around with the existing USD-RO parity cannot be people friendly.

Upswing for US Dollar?
The situation that we are facing today is unusual. We have not seen it in our history. The entire trade balance has shifted. Previously, we were all dependent on the US and western economies, which were major consumers and the rest of the nations were supplying. People are expecting that we are going to see a cycle in which there is a possibility of recession in the US – a prolonged one at that. That is the reason why even the Fed has reacted much more than the market expected. The market expected only a 25 basis points reduction. Instead, the Fed Reserve went for a 50 basis points cut. So, obviously they are concerned about the credit problem; also about the economic cycle turning negative. So, with this entire situation, obviously we are not seeing a turnaround, or probably we are seeing a sharper slide. We are going to see a further cut in the interest rates. If it sustains US growth, it is fine. But if there is going to be a negative trend starting from this quarter onwards, then the US is heading for trouble. If the Dollar goes down, the interest rates will go further down. May be it will go down to say: 3.5 per cent, a level at which the US Dollar is going to get a further beating – may be see another 5-6 per cent depreciation!

Can the Omani Rial take such depreciation in the US Dollar? What will be the exchange rate at that point in time, if the RO takes that? No doubt, these people are trying to keep oil prices higher; OPEC is trying to play by just giving political statements. Of course, supply has not dropped. So. today’s US$80 is equivalent to US$68 in real terms because of the depreciation of currency. So, effectively, you are not gaining on it. Obviously, revaluation has to be considered.

Policy Issues
I am clueless as to what the Central Bank of Oman can do. The region just follows what the US does in terms of monetary policy actions. They have not developed an expertise for that.

Again next month, if there is going to be a further slash in the rates by Fed, can we once again say ‘sorry, that ours is a different economy, you cut the interest rate and we will not do it’. We will have to do it. What Kuwait did, was fine. The only bold step it had taken was to change its currency basket instead of relying solely on the US Dollar. That is the big step towards having your own monetary policy. Take Kuwait’s case. Around 60 per cent is US Dollar rate and the rest is mixed, which is a realistic scenario. Today, 40 per cent currencies of the goods imported are from non-Dollar based locations and the rest is US Dollar linked. So you are balancing it. Once you balance it, then you do not have a problem on the external front. In the global scenario, you can still be competitive. Going forward, you can also control inflation.

Reserves Conundrum
Let us get down to basics. Now, in terms of exports earnings, it is all in US Dollars. Now, all Dollars are parked in Dollar-denominated assets. All reserves and balance sheets are awash with Dollars. If they start doing things such as depreciating or revaluing, then it will impact them significantly on the reserves front, which can be a disaster.

Kuwait is slowly moving into different currencies. None of the other governments have done this so far, which clearly shows that they do not have an inclination of changing the peg. They have not experienced it before. This is probably the first cycle in which they are experiencing such a contrasting situation, by which you see the USD going down and your economy is prospering. And you want to sustain your economy, but the US is dragging you down. They have been supplying oil to the US in huge quantities for a long time. Due to a possible slowdown, if US were to buy less, it will impact the oil exporting Gulf countries. Surprisingly, today suppliers are going to Asia. So your export revenue is coming as usual despite the US slowing down. This is a unique situation, which they have not experienced so far. They have to come out with innovative solutions.

– As told to Jayashankar Menon

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