Kuwaiti Dinar

This seems to be a tempest in a teapot, but wanted to see what others here think about the situations with the Kuwaiti Dinar and maybe more broadly in the GCC union.
Kuwait abandons US dollar currency peg

Kuwait on Sunday removed its currency peg to the US dollar, throwing plans for a Gulf currency union by 2010 into doubt and raising the prospect that other oil-producing states might abandon long-held dollar pegs.

Sheikh Salem Abdelaziz Al Sabah, governor of the Central Bank of Kuwait, told the official Kuwait news agency that the decision had been made owing to the "detrimental effects of the pegging system to the national economy".

Since late last year, Kuwaiti officials have hinted that the country would revert to a basket of currencies to prevent the sliding dollar increasing the cost of imports, which has stoked inflation to more than 4 per cent, double the historic average. This has encouraged speculators to plough billions of dollars into the dinar over the past few months, betting that the central bank would allow the dinar to appreciate.

On Sunday, the dinar traded up 0.4 per cent as the central bank replaced the peg with a basket of undisclosed currencies. The central bank had allowed the currency to vary up to 3.5 per cent from the peg, but the dinar had been at the top end of the approved trading band for a year owing to the continuing weakness of the dollar and the strength of Kuwait's oil-driven economy.

The dollar is expected to make up about 75-80 per cent of the new basket, reducing the third largest Arab oil exporter's exposure to the weakening dollar.

Kuwait dropped its currency basket in 2003, adopting a dollar peg as part of the Gulf Co-operation Council countries' drive to create a unified economic block with a single currency by 2010. But doubts over the ability of the GCC economies to harmonise have arisen, with one member of the six-nation council, Oman, saying it would not meet the convergence criteria.

"There have already been a lot of question marks over currency union taking place; this raises an additional one," said Simon Williams, an economist with HSBC in Dubai.

Kuwait's move may come as a surprise to other GCC states, such as Saudi Arabia and Bahrain, which have been repeating their commitment to the peg in recent weeks, saying that any revaluation should be agreed collectively by the GCC.

Mr Williams did not believe other GCC states would follow suit on revaluation quickly, as these countries have clung to dollar pegs since the early 1980s.

But other GCC states - Saudi Arabia, the United Arab Emirates, Bahrain, Qatar and Oman - are studying the move as an option to mitigate dollar weakness.

Really nothing of major ground-breaking stuff.
Pegging a nations currency eliminates or so severely restricts monetary policy to make it nearly ineffective, thus exposing the country to the whims of the world wide economic fluctuations-especially with respect to inflation.

So 0.4 percent is really nothing. And even after the basket is changed it will still contain 75-80% US dollars. So a little less trading in dollars to maintain its basket equilibrium.

But a country of Kuwait should not peg its currency unless it is trying to join a monetary union. It might be interesting looking more into the GCC. As I remember a monetary union has a lead country that pegs its currency to another stable currency (US Dollar) or a basket and all others countries peg to that lead country.
Kuwait reviewing exchange rate, dollar peg

BENEFITS OF THE PEG
“Inflation is one of the drivers,” Humaidhi said, adding the government expected annualised inflation in 2007 to match the 3.1 per cent recorded last year. “Kuwait moved from a basket (of currencies) to the dollar. We are considering whether this is the right idea and what benefits we are from getting this,” he said.

Kuwait switched the dinar’s peg from a basket of currencies to the dollar in 2003 to prepare for monetary union with Saudi Arabia, the United Arab Emirates and three other Gulf oil producers. With the monetary union timetable in doubt after Oman, one of the six, opted last year not to meet the 2010 deadline, speculation has grown that some Gulf states would revalue their currencies. Kuwait was named as the top candidate for a revaluation in a Reuters poll of analysts in March. Standard Chartered’s Brice said he expected Kuwait to revalue the dinar by 1 per cent. Deutsche Bank expects the currency to appreciate 3 per cent in six months.

Speculators piled pressure on the dinar in the runup to a Gulf central bankers meeting in April that was expected to hammer out a deal to revive the monetary union plan. The talks ended inconclusively. In March Kuwait’s central bank warned speculators against betting on an appreciation of the dinar and followed up by cutting key interest rates to make dinar-denominated assets less attractive.

But the one thing about having a peg or in this case a trading band, speculators such as George Soros have a one way sure bet. This does not look to be much of a reward though at 4% for a 6 month span. Now it becomes a question if the real interest rates are higher than the rest of the world.

And the last sentence is funny since cutting interest rates could lead to inflation and defeating the purpose of changing the exchange regime.

And what does the IMF think:

"Significant progress toward regional integration has already been achieved through elimination of barriers to free movement of goods, services, capital, and national labor; and a common external tariff. All GCC countries continue to have strong macroeconomic fundamentals characterized by large surpluses in the fiscal and external current account positions, credible pegged exchange regimes, and low nominal interest rate environments. I continue to strongly support the objective of establishing a GCC monetary union by 2010. Achieving this important objective within the agreed timeframe will however require accelerating the preparatory work to put in place the necessary institutional framework and infrastructure. The Fund stands ready to assist by providing policy advice and technical assistance in our areas of its expertise." IMF Managing Director Rodrigo de Rato Welcomes the Large Investment Programs in the GCC Countries and Highlights the Importance of Planned Monetary Union

A very nice review of the economy of Kuwait is from the IMF of course:
Kuwait: 2006 Article IV Consultation—Staff Report;