Several Gulf countries have discussed receiving dollar swap lines from the US, theWSJ reported last week. In the near term, there is an economic drag if volumes of oil and gas sales have fallen by more than the price effect can offset, or where tourist and business travel has dried up. The effect is similar to that of the pandemic: slowing growth and fiscal revenues, and accelerated demand for fiscal spending.

As the WSJ reported, UAE. Central Bank Gov. Khaled Mohamed Balama had raised the idea of a currency-swap line with Treasury Secretary Scott Bessent and Treasury and Federal Reserve officials in meetings in Washington. The Emiratis emphasized that they had so far avoided the worst economic effects of the conflict but might still need a financial lifeline.

The talks highlighted the U.A.E.’s concern that the war could inflict major damage on its economy and its position as a global financial hub, depleting its foreign reserves and scaring away investors who once saw it as a stable and secure place for their money. The conflict has damaged Emirati oil-and-gas infrastructure and shut off their ability to sell oil using tankers transiting the Strait of Hormuz, depriving it of a key source of dollar revenues. Meanwhile tourism, another key source of hard currency, has also been throttled as a result of regional instability.

Emirati officials haven’t made a formal request for a swap line, which would give the UAE. central bank inexpensive access to dollars to support its currency or shore up its foreign reserves in case of a liquidity crisis. A swap line would also avoid forcing a liquidation of dollar-denominated assets. The Emirati officials argued that it was President Trump’s decision to attack Iran that entangled their country in a destructive conflict whose effects may not be over; they added thatif the U.A.E. runs short of dollars, it may be forced to use Chinese yuan or other countries’ currencies for oil sales and other transactions, strongly hinting that UAE may be forced to seek financial backing from Trump's arch-nemesis.

In that scenario is an implicit threat to the U.S. dollar, which reigns supreme among global currencies partially because of its near-exclusive use in oil transactions.

Gulf central banks hold dollar reserves in liquid assets like Treasury bonds and bills. However, using these reserves for fiscal support would be unwise according to UBS economist Paul Donovan who noted that "it would rapidly call into question the stability of the region’s currency pegs to the US dollar."

The Emirati dirham is pegged to the dollar and backed by foreign-currency reserves of $270 billion, but the war has put it under pressures from capital-flight risks, stock-market volatility and other disruptions, analysts said.

The credit-rating firm S&P Global said in a March 6 report that the U.A.E.’s “substantial fiscal, economic, external, and policy flexibility will act as an effective buffer” against the war’s economic effects. But it warned that “the potential for prolonged disruption” to its oil exports and damage to infrastructure “add clear risk to our expectations.”

The Fed used swap lines heavily used during the 2008 financial crisis, buying the currency of other borrowing central banks with dollars and later selling it back. It also used swap lines to support foreign central banks after the start of the Covid-19 pandemic. Countries that don’t have a swap line with the Fed can still exchange their holdings of Treasury bonds for dollars through a program administered by the New York Fed.

Gulf sovereign wealth funds are different. The region’s wealth fund holdings (in excess of USD 5 trillion) are not for currency stability, but to provide long-term income streams.Gulf sovereign wealth fund holdings skew toward US dollar-denominated assets, but they are generally held in less liquid assets.

Source: ZeroHedge News