EFTA01459710.pdf

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 Figure 4: SA reserves offer protection but the Omani Hong Kong and Denmark. In cases where the dinar looks vulnerable as C/A deficit widens out... economic rationale for keeping a peg outweighs the loss of independent monetary policy the central bank 35 will go to great lengths to defend it. Saudi Arabia 30 -; endured several periods of deflation in the 80s and 90s 25 .1 because they have little to gain from devaluation. Chief 20 Saudi economist Melhem Melhem notes that 15 - devaluation will not restore competitiveness as oil 10 dominates exports and imports of labor and materials 5 would suffer immediate pass-through inflation. 0 1 -10 Saudi Arabia Oman Further fiscal consolidation is the key for longer-term —Bahrain UAE -15 peg stability. The Saudi government is intensely -20 I —Qatar focused on this issue, having just announced a 50-66% -25 increase in fuel prices. More radical reforms could include introducing income taxes, reducing subsides on 00 02 04 06 08 10 12 14 16 18 20 education, health care and housing, or further reducing San, one. Bent Stettin agninNIA subsidies on electricity and water (The Economist, "The Saudi Blueprint", 9-Jan 2016). But FX forwards !Figure 5: ...as reflected in the 12m forwards (carry) markets were underwhelmed by last month's budget proposals. DB strategist Aleksander Stojanovski notes that while the announced budget of 5224bn would Saudi Arabia result in a S87bn shortfall (13% of GDP) off projected revenues of $137bn, actual spending typically exceeds Oman budgeted spending by 25%; the latter would produce a —Bahrain 21% of GDP budget deficit (see MENA Strategy, 29- -UAE Dec-15). The authorities appear more committed to Qatar meeting the budget this year with military overruns the key risk as regional conflicts (ISIS, Yemen) intensify. Oman. Bahrain tar :tare vulnefable. pgg safe —7. Our recommendation is to watch the 12m USDSAR forward for better entry levels to buy. The spring 2015 May Jul Sep Nov Jan Brent rally was one such opportunity; 12m SAR Saes SF, away sari Nana Report (6thisti 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): Figure 6: Lower reserves and high oil budget breakevens go hand in hand 1. Oman: The IMF projects a staggering 15%+ Omani C/A deficit through 2020 even as the Saudi and Qatari C/A return to balance in 400 120 2018; unsurprisingly OMR forward points have 300 spiked (Figures 4-5). 200 2. Bahrain: DB strategist Oliver Massetti notes the Bahrain oil budget breakeven price 100 exceeds S120 and reserves are quite low (Figure 6). Surprisingly, 12m BHD forward o 0 points are indicatively trading below SAR. sea° ores` ooto 41*-4.,,yen,* While the May 2015 USDSAR entry point may appear obvious in hindsight, and unlikely to repeat, markets Government assets, % of GDP have time and again proven to have short memories. If <>Budget breakeven of pnce 2015, USDibbl (rho) we see sub-400 levels in 12m USDSAR forward points Sown SF,Ilassal• honor Alps, Seinen) again it will be time to buy but for now the trade is too expensive to enter. Daniel Brehm London +44 20 754 50946 Page 28 Deutsche Bank AG/London CONFIDENTIAL — PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0120348 CONFIDENTIAL SDNY_GM_00266532 EFTA01459710