Government Intervention in Exchange Rate Market of the

Kuwait has a strong exchange rate and the government move from US dollar pegging to pegging with the GCC currencies to control the inflation rate. The government intervenes in the exchange rate market to manage price equilibrium, to raise competitiveness, to motivate financial stability, to change inflation trends and to stable the rate of interest. There are different indicators that are required to be focused by the government of Kuwait to intervene in exchange rate markets such as development phase of the country, vulnerability to shocks, financial markets progress and integration of government with global markets and other states of the world.

Forms of Intervention of Exchange Rate Market of the Kuwait

There are several forms of government intervention in the exchange rate market as

Direct Intervention: It is a form of intervention by the monetary authorities of the country to manage the exchange rate. It is used to change the monetary base and for the stability of the monetary base of Kuwait. It classifies into sterilized and non-sterilized intervention. In the sterilized intervention monetary base remains the same and in non-sterilized intervention, the government changes monetary base. The central bank of Kuwait intervenes directly by purchasing and selling securities and bonds and impact the exchange rate.

Indirect intervention: It is a technique of impacting exchange rate in an indirect way. In the year 1984 when the stock prices declines in Kuwait then government intervene indirectly by purchasing stocks to raise the prices and it also impacts the exchange rate of Kuwait (Roger, 2014).

These forms of government intervention show as how Kuwaiti government can intervene in the exchange rate market by changing the monetary base or through indirect manner.

Kuwait Monetary Policy of Exchange Rate Market of the Kuwait

In the State of Kuwait, monetary policy is implemented and set by Central Bank of Kuwait in accordance with the 1968’s Law No. 32 concerning Currency, the Organization of Banking Business and the Central Bank of Kuwait. The prime objective of monetary policy is to maintain monetary stability so that the impacts of inflation could be mitigated. A related objective that the Law has mandated is that the monetary policy of Kuwait needs to be managed in a way that could enhance the economic as well as social progress along with the growth of national income. 

Central Bank of Kuwait in monetary policy also focuses the efforts to maintain the banking system’s financial stability through the macroprudential instruments’ use involving bank credit, monitoring bank liquidity, and monitoring as well as introducing the prudential regulations (Central Bank of Kuwait, 2018).

Following are the major objectives of the monetary policy of Kuwait:

Relative stability’s maintenance in the Kuwaiti currency’s purchasing power.

Availability of bank liquidity’s adequate levels.

Supervision over the trends as well as the volume of bank credit.

Development of both the capital markets and money markets in Kuwait.

Reinforcement of the banking system’s role by supervision over it.

Kuwait Central Bank Intervention

The central bank of Kuwait intervenes in the key discount rate of Kuwait that remain unchanged at 3 percent in 2018. This decision of Central bank of Kuwait followed the announcement regarding twenty-five basis point interest rate that the Federal Reserve of United States has hiked.

In contrast to the Gulf Arab states that are rich in oil exporting that peg their currencies to the United States dollar having a small room for the independent monetary policy, Central bank of Kuwait manages its local currency against the undisclosed currencies’ basket in which a major role is being played by the dollar. This intervention by Central bank of Kuwait gives more room to Kuwaiti currency to diverge from the policy of the United States if it is believed that it is warranted by the domestic economic conditions. When the Fed last increases its rates a few months ago, the Central bank of Kuwait kept the key rate unchanged as well.

It was stated by Mohammad al-Hashel, governor of the central bank, that instead of increasing the rate of discount, it is better for the banks to use other policy tools so that money market could be managed, such as Islamic instruments and issues of bonds, term deposits’ acceptance from local banks of Kuwait, and direct interventions of Central bank of Kuwait. It was noted that domestic credit of Kuwait banking system was growing only modestly due to the tepid growth in the economy’s non-oil areas. It has shown by the recent data the Central bank of Kuwait has the ability to maintain a stable margin between dollar deposits and rates on dinar so that local currency of Kuwait would be attractive to investors, along with the stable margin between dinar loan of banks and deposit rates of banks (Reuters, 2018).

The logic for Central Bank Intervention:

Central bank of Kuwait, in order to ensure the bank credit’s availability that is sufficient to finance economic activities of Kuwait that so productive in the non-oil industries and to keep such finance’s cost as low as possible, helps local banks of Kuwait to check the shortage in bank Kuwait Dinar liquidity by means of swaps, discounts, loans and deposits by Central bank of Kuwait with commercial banks of Kuwait. The policy of Central Bank in supplying local currency liquidity to commercial banks consist of two major factors affecting the trends and volume of bank credit. Following are these two major factors:

The rate of interest that is charged by the Central bank of Kuwait. This rate of interest impacts the funding cost obtained by commercial banks from a Central Bank. Moreover, this impacts the interest rates level charged on loans that commercial banks grant to their customers.

The funds’ volume that the Central bank of Kuwait agrees to provide to commercial banks in Kuwait, and the relevant conditions that the Central Bank sets in this regard. Some of the conditions that Central bank of Kuwait sets relate to the economic activity of Kuwait that should receive funds.

Personal Opinion on Central Bank Intervention:

The recent intervention of the Central bank of Kuwait in 2018 seemed to be a really sensible approach as it strengthened the domestic currency of Kuwait and kept the exchange rate maintained. Furthermore, 2013, the Central bank of Kuwait increased the rate of discount that might have looked bad at that time but it is proved that this decision was very good for the stability of inflation in Kuwait. The intervention of the Central bank of Kuwait overall has been in the favor of country this is why it is highly encouraged.

Cost and benefit analysis through government intervention in the exchange market:

The main advantages through different interventions of the central bank of Kuwait in the exchange rate market are as follow;

Strong active management of official reserves

Diversification of investment

The increasing official assets have been channelized other than the major reserves of Kuwait as oil earnings that make the country to pay foreign debt on prior basis. In 1973 when oil prices decline and share prices also decrease then the government of Kuwait intervene by purchasing shares of Oil Company and create demand and prices to increase. The central bank also decreases the exchange rate that again manages the price fluctuations of oil shares in 1973.

The cost-benefit analysis for the central bank of Kuwait is described through recent changes of the central bank of Kuwait. Kuwait moves from US dollar pegging to basket pegging to pegged currency with the GCC currencies. The benefit linked with intervention is more as compared to cost and advantages are long-term favor for the Kuwaiti exchange rate. The advantages of this intervention are stable inflation, stable interest rate and it also makes Kuwaiti dinar to regain its lost value. It also leads to flexible financial policies, foreign exchange reserves raises and it also gives several benefits to investors through basket pegging.

The government intervenes also give benefits of control inflation, stable monetary policy, control money supply etc. (Occasional Papers, 2016).

A recent example of Kuwait government intervention in the exchange market:

The first direct intervention by Kuwaiti government in exchange market seen in 1990 during the Iraq-Kuwait war. The recent example of government intervention is in the year 2014 that is mention in the report of IMF. When Kuwaiti government intervene and change US dollar pegging with basket pegging to match Kuwaiti exchange rate with GCC currencies and it is appropriately justified in an economic manner. The government of Kuwait does not intervene much in the exchange rate market. In 2014 the exchange rate of Kuwait was declining and inflation was rising. The government intervenes to manage low liquidity in the market and to cover the impacts of recession with the use of swaps in the market. In the year 2013, the Kuwaiti government increases discount rate for the stability of inflation trends and government for intervention issue Kuwaiti dinar the US swaps to manage market liquidity and to manage inflation. The government intervenes through open market operations (IMF, 2016).

Impact of current policy on economic ability of every GCC country in setting rate of interest:

The four major members of GCC countries are involved in basket pegging that is their current policy of exchange rate. UAE and Oman do not involve in basket pegging. The present policy limits the economic ability of every member of GCC to set its rate of interest and joint financial unit of GCC country make states to adopt similar economic trends because it raise cooperation and introduce GCC as one block but it also limits the GCC ability to set own interest rate on the basis of economic scenario. It makes the GCC states to follow similar trends of interest rate. The distinctions in trade conditions, oil exports, and other economic factors need a change in policies for setting rate of interest. For example, the inflation in Saudi Arabia is rising and it needs the intervention of central bank to manage the inflation by enhancing the rate of interest but Saudi Arabia find it complicated to set own interest rate before of unification of financial policy. In the same manner, the other countries except UAE and Oman cannot make changes in the rate of interest according to the economic indicators and conditions of the financial markets. The figure mention below is showing the interest rate for fifteen years for the major countries of GCC in comparison of US (IMF, 2016).

Conclusion of Exchange Rate Market of the Kuwait

It is concluded that the Kuwaiti government intervenes exchange rate market to manage price equilibrium, to raise competitiveness, to motivate financial stability, to change inflation trends and to stable the rate of interest. There are two major forms of government intervention as direct intervention and indirect intervention and Kuwaiti government can intervene in the exchange rate market by changing the monetary base or through an indirect manner. The recent example of government intervention is in the year 2014 when Kuwaiti government intervene and change US dollar pegging with basket pegging to match Kuwaiti exchange rate with GCC currencies for increasing exchange rate and for managing the inflation in Kuwait.

References of Exchange Rate Market of the Kuwait

Roger, K. (2014). Executive Summary of Government Intervention in Exchange Rate. Retrieved 15 November 2018 from http://www.state.gov/documents/organization/231064.pdf.

Occasional Papers. (2016). Cost and Benefits of Intervention. Retrieved 15 November 2018 from https://www.ecb.europa.eu/pub/pdf/scpops/ecbocp43.pdf.

IMF. (2016). Exchange Rate intervenes of Countries. Retrieved 15 November 2018 from https://www.imf.org/external/pubs/nft/2014/areaers/ar2014.pdf.

IMF. (2016). The GCC Monetary Union—Choice of Exchange Rate Regime. Retrieved 15 November 2018 from https://www.imf.org/external/np/pp/eng/2008/082808a.pdf.

Central Bank of Kuwait. (2018). Monetary Policy Objectives. Retrieved from http://www.cbk.gov.kw/en/monetary-policy/monetary-policy-objectives.jsp

Reuters. (2018, September 27). UPDATE 1-Kuwait central bank keeps rates on hold after Fed hike. Retrieved from https://www.reuters.com/article/kuwait-rates/update-1-kuwait-central-bank-keeps-rates-on-hold-after-fed-hike-idUSL8N1WC61P