What would it mean if Qatar dropped the dollar peg?

The United States dollar (USD) priced oil and gas sector accounted for 58 percent of Qatar’s economy and 59 percent of its exports in 2012, and that hydrocarbon receipts represent some 70 percent of the government’s budget income on an ongoing basis. So it is little surprising to see markets affected by recent hints from QCB governor Sheikh Abdullah bin Saud Al Thani that the Qatari riyal’s (QAR) peg to the USD may be abandoned.

Although the governor emphasised that no concrete plans to free up the riyal from the 3.64 fixed rate against the USD that has stood since 2001 are in place, one-year USD to QAR forward prices dropped by 45 points, ostensibly the lowest level since June 2012, on the comments. Indeed, this was the first from a leading Qatari policy-maker to publicly suggest that the country may change its dollar peg anytime soon. 

In broad terms, as Qatar seeks to diversify its economy away from the oil and gas industry, it would make increasingly good sense to at least reduce the country’s dependence on the US economy as transmitted through the USD, especially given the lack of monetary policy manoeuvring that this affords the country.

In flexible exchange rate systems, a natural tactic to combat inflationary threats would be to raise interest rates.

Indeed, already, according to a comment in May by Qatar’s erstwhile prime minister, HE Sheikh Hamad bin Jassim bin Jaber Al Thani, the recent performance of the USD has contributed about 40 percent to the inflation rate in Qatar, whose currency, he added, is undervalued by as much as 30 percent. In this context, although inflation is running a long way off the highs of 15 percent seen in 2009 – in April, the consumer price index (CPI) stood at 3.7 percent on an annualised basis, the International Monetary Fund projects that it will edge up to at least five percent in 2017 and 2018, and possibly even higher. This might happen given the increase in state-directed spending on a vast number of major infrastructure construction projects in the lead up to the World Cup 2022 being hosted by Qatar. 

Flexibility in exchange rates

In flexible exchange rate systems, highlighted Khalid Al Khater, director of research and monetary policy at the QCB, a natural tactic to combat these inflationary threats would be to raise interest rates. In Qatar’s case, given the relative undervaluation of the currency, this would not pose exchange rate problems if the rate was not fixed, allowing domestic demand to be choked, with no noticeable negative effects on importing inflation, particularly as it is energy self-sufficient. “We in the GCC need more than an outdated four-decade-old, simple uni-instrument, uni-tool macroeconomic policy framework,” he said, adding that, “this framework was suitable for the earlier stages of development. However, the world has changed.”

It is changing faster for Qatar than many would have thought even a few weeks ago, in ways that would argue for more currency flexibility than the USD to QAR peg would allow. This is most significant in light of the news that Morgan Stanley Capital International (MSCI) has raised the status of the Qatar Exchange in its investment indices to ‘Emerging Market’ from ‘Frontier Market’ status, after it undertook reforms to make foreign investment easier. It is true that the size of fund inflows directly caused by the upgrade is likely to be modest compared to the market’s size, with local analysts projecting roughly USD500 million (QAR1.8 billion) of inflows for Qatar.

QAR1.8 billion - Projected fund inflow to Qatar on the MSCI upgrade. 

Currently, however, by raising the region’s profile, MSCI’s decision may prompt many foreign investors to take a second look at it, and all the more so if there is the opportunity for positive interest rate carry from the currency itself as opposed to the USD’s virtually zero interest rate policy for the foreseeable future.