Kuwait abandons USD peg, weight seen at 75-80%

Kuwait has abandoned pegging its currency to the U.S. dollar and returned to linking it to a basket of currencies, the Central Bank governor announced. The fall of the exchange rate of the U.S. dollar has “contributed to local inflation,” and the Cabinet decided Sunday to peg the Kuwaiti dinar to a basket of currencies instead, the Kuwait News Agency quoted the bank governor, Sheik Salem Abdul-Aziz Al Sabah, as saying.

Kuwait’s Central Bank had previously switched from a basket of currencies to the greenback in 2003 to comply with requirements from a plan for a unified Gulf currency by the year 2010.

The six members of the Gulf Cooperation Council hope the move, similar to the creation of the Euro by the European Union, will boost regional trade and economic integration.

Along with Kuwait, the loose economic and political alliance groups Saudi Arabia, the United Arab Emirates, Qatar, Bahrain and Oman.

Despite the central bank’s decision, Kuwait remains “fully committed” to the unified Gulf currency by its target date of 2010, Al Sabah said.

The dinar has immediately strengthened against the dollar since dropping the peg.

BNP Paribas noted in a commentary that the new currency peg of Kuwait will have a USD weight of 75-80%. Kuwait is part of the GCC band and its decision to move away from the USD peg has effectively buried the 2010 target date for introducing a regional currency union, analysts noted.

Like the other GCC’s, Kuwait has faced increasing inflation pressure as its booming economy received an additional monetary impulse via its currency being dragged lower by the USD.

The Kuwaiti Dinar declined against other currencies including the Euro adding to price pressure already in place via local cost push factors. Now as Kuwait has abandoned its USD peg other GCC countries might follow with the UAE the next candidate, notes BNP Paribas.

While the USD weighting in the currency peg will be initially high it will be reduced gradually. Russia’s move towards a currency basket where the weighting of the EUR is now dominant can be used as an example, notes BNP Paribas. Since Russia abandoned its USD peg in 2003 it has been adjusting its currency reserves accordingly.

Kuwait has USD21.1 bln of official reserves and the entire GCC USD78.5 bln, but a multiple is held within future generation funds. Accordingly a shift of local reserves is likely to put the USD under more pressure. With the GCC USD peg now under threat and the regions imports coming mostly from Europe (33.5%), the pricing of oil and gas in USD no longer make economic sense.

The five other members of the GCC however, will likely not follow Kuwait in revaluing their currencies, the bloc’s secretary-general said.