Qatar and UAE exchange office in Doha, Qatar, June 13, 2017.

Naseem Zeitoon | Reuters

Qatar and UAE exchange office in Doha, Qatar, June 13, 2017.

Qatar‘s peg with the U.S. dollar is a potential headache – and a potent economic weapon. The emirate’s fixed currency has supported financial stability in a small country that overwhelmingly depends on energy exports. Tensions with Gulf neighbours may make fears of a devaluation of the riyal self-fulfilling. But breaking the peg could also turn the tables on Qatar’s enemies in the region.

Pressure has built up on the currency since an alliance led by Saudi Arabia and the United Arab Emirates imposed an economic blockade two weeks ago. They want Doha to sever ties with Iran and militant groups such as the Muslim Brotherhood, as well as shutting down its troublesome Al Jazeera news network. Food imports have been blocked and some exports disrupted. Qataris have been ordered to leave neighbouring states.

The blockade has hit confidence in the currency. On June 9, the riyal hit its lowest level since December 2015 in the offshore market, raising fears of a harmful devaluation. To defend the peg, Doha can ask its state-owned banks to buy more riyals, or raise interbank rates. But both strategies have limits. The longer the blockade drags on, the more expatriates – who account for 94 percent of the total workforce – are likely to withdraw their money. In the worst-case scenario, Qatar might have to impose capital controls to prevent cash leaving the gas-rich peninsula.

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But Qatar can afford to defend the peg – which has been in place since 2001 – at around 3.64 riyals to U.S. dollar. Despite weak energy prices it is likely to earn $70 billion in hydrocarbon export income and post a modest current account surplus this year. It can also fall back on about $36 billion of foreign currency and gold reserves without tapping its vast sovereign wealth fund.

Breaking the peg would probably trigger a faster rush to the exits, and lead to painful inflation. But it would also be potentially more dangerous for Qatar’s rivals. Saudi Arabia, the region’s largest economy, could find its own riyal under assault. Monetary policy coordination and the goal of a common currency across the Gulf Co-operation Council would likely collapse. In that instance Qatar’s currency peg could become a weapon of mutual destruction.

Commentary by Andy Critchlow, Middle East editor at Breakingviews. Follow him on Twitter @baldersdale.

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