Why GCC economies could see more of the yuan

In relation to growing cross-border trade.

A forex expert from Crédit Agricole Private Banking has forecast an increasing level of Chinese currency transactions in Gulf Cooperation Council (GCC) countries, to support the growing cross-border trade and investment flows between China, GCC and the wider Middle East region.

According to a release from Crédit Agricole Private Banking, it was noted that as the GCC’s largest trading partner, China is seen more to play an important role in the region’s businesses, and particularly with regard to commodity related activities and joint infrastructure investment projects.

"China is also using the region (and particularly the UAE) as a strategic hub for conducting business with Africa and wider Middle East," said Davis Hall, Global Head of Foreign Exchange & Precious Metals Advisory, Crédit Agricole Private Banking. He made these remarks at a media roundtable in Dubai last Friday.

"In this background, it can be said that China is increasingly becoming a major stakeholder for the GCC region. To further facilitate cross-border synergies, the adoption of the Chinese Yuan by local businesses would further boost trade and investments between China and the GCC countries."

Here's more from Crédit Agricole Private Banking:

Over the last few decades, China has become one of the world’s largest consumers of industrial commodities, with a global consumption level of 46%. This is leading to the upcoming IMF approval vote in November 2015 with regard to the Chinese Yuan’s status as a potential global reserve currency.

If the IMF votes the Chinese Yuan as a global reserve currency, its value may outperform GCC currencies over time and consistently chip away the default position enjoyed by the US dollar as a global reserve currency over the last few decades.

Davis Hall continued, “The inevitable albeit gradual internationalisation of the Chinese Yuan will steadily attract investors of all sorts to this counterbalancing global reserve alternative.

Many countries are recognising this eventuality and setting up necessary platforms to fully leverage existing and future trade relationships. Interestingly, Qatar recently set up the region’s first offshore Chinese Yuan clearing centre to facilitate greater trade and economic links between China and the GCC region.”

At present, the hydrocarbon economies of the GCC region use the US Dollar much more than the Chinese Yuan as most GCC currencies are pegged to the US Dollar and it is the default currency for oil trading.

This oil-USD-peg connection also leads GCC countries to hold most of their huge forex reserves in US Dollars. Another aspect is that currently the Chinese Yuan is not a fully convertible currency which limits its attraction as a reserve currency for central banks.

“Nevertheless this present situation could evolve as cross-border trade (oil and non-oil) volumes rapidly grow. With the recent trends in oil prices, never before has the price evolution of a single commodity so directly influenced the foreign exchange markets.

The knock-on effects of OPEC's decision to protect market share and maintain output levels last November has sent shock waves and FX dominos falling. The impact of this oil-specific catalyst has served to draw the sleepy FX markets out of hibernation and into trending motion. The undesirable side-effect has been to see a resurging US dollar with all the pegged GCC currencies in tow, added Davis Hall.

This critical situation and disinflationary effect of ‘lower oil and stronger US Dollar scenario’ has led to a complete reshuffling of the cards. In this context, winners and losers are emerging as many central banks are seen to gradually ease monetary policy since earlier this year.

Davis Hall continued, “In a low oil price and strengthening US Dollar scenario, there is a lot of pressure on OPEC as it goes into its June meeting.

The GCC countries are essentially dollarized economies, and OPEC has to carefully examine its output strategy decision as it could be crucial for this region. There is also the upcoming detente in Iran and this is yet another potential headwind for oil given its effect on the already precarious supply-demand calculus.”

Another theme which could be important for the GCC’s US Dollar pegged currencies is the upcoming Fed policy normalization and the ongoing strengthening view on the dollar.

For the first time since 1989, the US Dollar (and pegged currencies like that of the GCC) have outperformed every single alternative within the G20. There have already been visible consequences to this US Dollar strengthening phase which will influence the FOMC (Federal Open Market Committee) meeting’s timing and scope of its inevitable interest rate 'normalisation' phase.

“Therefore, the 'later and less' camp has a growing following ever since the NY Fed stated that the recent US Dollar strengthening could well shave a full 0.6% off 2015 GDP.

In our view, the risk-reward balance is less and less tipped in the US Dollar's favour beyond the over obsession for a Grexit eventuality. Over time, several AAA alternative currencies are soon to claw back lost ground and surprise us by year-end unlike the unilateral dollar dominance of 2014,” concluded Davis Hall.