Qatar has decided to peg its currency, Qatari Riyal (QAR), to the US dollars on 9th July 2001. This peg is at a fixed exchange rate of USD 1 to 3.64 QAR with an upper and lower limit of fluctuation set being 3.6415 QAR and 3.6385 QAR, respectively.
A fixed exchange rate refers to an exchange rate that is fixed by the central bank of a country in response to a change in currency supply and demand. A dollar peg refers to a country maintaining its currency’s value at a fixed exchange rate to the U.S. dollar. Such an act is achieved in Qatar when its central bank controls its currency value so that it may rise and fall along with the dollar value.
By controlling the worth of QAR, constant government interventions must take place by adjusting both the demand and supply in the Forex Exchange Market, as depicted in the diagram above. Currently, with the exchange rate of 1.00 QAR = 0.275 USD, the value is fixed at point ‘X,’ but it does not necessarily mean it will remain at this stage. For instance, if the exports fall in Qatar, they will face a decrease in demand for their currency, which shifts the demand curve from D1 to D2. In a floating economy, the value will naturally fall to a worth of 1.00 QAR = 0.1 USD at point ‘Z,’ however, a fixed exchange rate at 3.64 QAR means the demand must go back to D1, which can be achieved in two ways. Firstly, having Qatar’s central bank to purchase QAR on Forex by selling foreign reserves, thus increasing the demand from D2 back to D1 to point ‘X.’ Alternatively, having Qatar’s central bank to raise interest rates to attract foreign investors or imposing quota to decrease the supply from S1 to S2 to point ‘Y,’ again back at the level of 3.64 QAR to 1 USD. Vice versa, if demand decreases, Qatar will function oppositely to keep their currency pegged to dollars.
Being peg to the world’s most reserves currency, dollars, it brings numerous benefits to countries such as Qatar. Firstly, a dollar peg ensures the high stability of the currency, which is undoubtedly essential. Though Qatar has the highest GDP per capita in the world, however, they rely heavily on their exports of oil and natural gas, if they do not peg to the US, upwards fluctuations may easily devastate their economy as the oil becomes less competitive thus pegging to a strong currency is beneficial in preventing such volatility. In addition, it promotes high foreign investments. As firms and individuals acknowledge Qatar’s dollar peg, they are more likely to invest in this country since they know the fixed exchange rate will not be easily eliminated their investment’s value. Moreover, low inflation may be achieved in Qatar, since a constant exchange rate provides stability in the price for both imports and exports and lowers the chance of QAR devaluating. Lastly, with the exchange rate fixed against the US, Qatar will not have to worry about any currency speculations.
On the contrary, pegging a currency certainly still takes effort and may bring about negative consequences. For starters, constantly maintaining foreign reserves and intervention is a requirement for Qatar’s government and central bank, they need to ensure the amount of the reserves in order to obtain the ability to trade back their own currency when needed. If Qatar runs out of foreign reserves, the peg may be eliminated, while, if they hold on to large amounts, it may cause high inflation. Furthermore, Qatar will be unable to operate a monetary policy to deal with domestic issues, since interest rate must remain constant to conduct the dollar peg. Finally, such an inability of monetary policy leaves Qatar with the only option of contractionary fiscal policy to limit imports when they face a current account deficit; in the long run, it may cause a recession to occur or deepens if it already exists.
In conclusion, a currency peg decision certainly brings both pros and cons to Qatar’s economy. However, in my opinion, pegging towards such a stronger currency like the US is beneficial and outweighs the potential drawbacks as this allows them to gain higher stability for their currency and attract more investments into Qatar. But ultimately, they need to be aware of the potential high inflation and inability to undergoing monetary policy to deal with economic slowdown or boom.