12 January 2016 FX Blueprint: Forever Young Gulf pegs made economic sense it you can keep them There are lessons from sturdier pegs as well, notably Hong Kong and Denmark. In cases where the economic rationale for keeping a peg outweighs the loss of independent monetary policy the central bank will go to great lengths to defend it. Saudi Arabia endured several periods of deflation in the 80s and 90s because they have little to gain from devaluation. Chief Saudi economist Melhem Melhem notes that devaluation will not restore competitiveness as oil dominates exports and imports of labor and materials would suffer immediate pass-through inflation. Further fiscal consolidation is the key for longer-term peg stability. The Saudi government is intensely focused on this issue, having just announced a 50-66% increase in fuel prices. More radical reforms could include introducing income taxes, reducing subsides on education, health care and housing, or further reducing subsidies on electricity and water (The Economist, "The Saudi Blueprint", 9-Jan 2016). But FX forwards markets were underwhelmed by last month's budget proposals. DB strategist Aleksander Stojanovski notes that while the announced budget of 5224bn would result in a S87bn shortfall (13% of GDP) off projected revenues of $137bn, actual spending typically exceeds budgeted spending by 25%; the latter would produce a 21% of GDP budget deficit (see MENA Strategy, 29- Dec-15). The authorities appear more committed to meeting the budget this year with military overruns the key risk as regional conflicts (ISIS, Yemen) intensify. Oman. Bahrain tar :tare vulnefable. pgg safe Our recommendation is to watch the 12m USDSAR forward for better entry levels to buy. The spring 2015 Brent rally was one such opportunity; 12m SAR forward points fell from 200 to a low of 15 in May. Meantime other Gulf dollar pegs are under more pressure (Kuwait pegs against a basket): 1. Oman: The IMF