Significantly, one justification was missing from the formal communique: the dollar/euro exchange rate. In the weeks leading up to the Algiers meeting, a number of Arab oil ministers had been pointedly defending oil prices above the declared $22-28 target bracket with references to the deterioration of the dollar over the last two years. The message was clear: don't just look at the nominal price of oil, but also consider the purchasing power of petrodollars.

The decline of the dollar is, arguably, the single biggest problem for the GCC's economic planners. Most of their planets have been in perfect alignment over the last 12 months. Strong oil and high production levels have produced substantial fiscal and current account surpluses - and the generation of massive liquidity which has fuelled broad gross domestic product (GDP) growth. Add to this interest rates near the floor and little evidence of inflationary pressure, and all looks good.

But the picture is incomplete. With all GCC currencies directly pegged to the dollar, the greenback's movements against other currencies are mirrored. And the dollar has been unwinding at an accelerating rate over the last 20 months. Its 12-month average shed over 5 per cent against the euro in 2002 and a further 16 per cent last year.

The impact of this on the GCC is broad. First, it has a direct impact on the fiscal position. The vast majority of regional government revenues come from petrodollars and some of the other income is effectively dollar-denominated due to the fixed exchange rate. But a growing proportion of government expenditure goes on goods and services from the eurozone, the UK and Japan - all of which have seen their currencies firm up against the dollar. As figure 1 shows, the import of goods from the eurozone has been increasing both in absolute and proportional terms over the last few years. In Saudi Arabia, for example, it now accounts for more than a third of imports. Clearly, the declining value of the dollar has weakened purchasing power.

The same phenomenon can be measured from the opposite direction. For all the warning cries in the US about the dangers of strong oil, in euro terms the oil price has been stable and comparatively low since early 2003 (see figure 2). Equally, even allowing for the sharp increase in oil production by most regional exporters, if oil revenues were denominated in euros rather than dollars, 2003 would only have been viewed as a good - rather than great - year. In euro terms, none of the major exporters earned more than they did in 2000 and a handful fared worse than in 2001.

In fact, there has been an intriguing statistical correlation between the swings in the average annual OPEC basket price and the dollar/euro exchange rate in recent years. In 2002, the average oil price rose, in dollar terms, by 5.4 per cent, while the dollar depreciated against the euro by 5 per cent. Last year, the pattern was continued. The OPEC price basket soared 15.5 per cent, while the dollar shed 16.3 per cent. It would be flattering OPEC to suggest that the correlation was carefully managed through market-massaging media manipulation and gentle touches on the production tiller. However, the underlying policy direction is clear: OPEC may have declared its price target in dollars, but close attention is being paid to what those dollars are worth. Is this policy sustainable? It is difficult to see further depreciation of the dollar being matched by oil price hikes without revenue-limiting production costs.

There are alternatives. OPEC could formally adjust its $22-28-a-barrel price target. Or it could make the model more sophisticated by introducing purchasing power parity into the OPEC price basket. The most radical move would be to start pricing oil in euros. In the medium term, none are likely.

Qatari Minister of Energy & Industry Abdulla bin Hamad al-Attiya, when asked about pricing oil in a different currency in mid-January at MEED's Major Project Opportunities in Qatar conference, gave an explicit rebuttal: 'It is very complicated to switch to a new currency. In OPEC we have decided not to discuss it.'

Moving the formal price target is also not imminent. 'This would achieve nothing as the target range is nothing more than a convenient handle to hang statements on. When it is not convenient it is quietly dropped,' says Geoff Pyne of Sempra Energy Trading. 'The aim is still to maximise revenues, and moving the target doesn't change this.' Neither is the introduction of a foreign exchange rate variable into the pricing basket on the horizon. 'Periodically, there is talk about this, but it won't happen soon, or at all,' says Barclays Capital's Kevin Norrish. 'It would require an awful lot of research, which hasn't even started. Second, it would politically be very difficult to establish the framework for the model. And lastly, it wouldn't even be beneficial: it would just introduce more volatility into the market by factoring in forex [foreign exchange] markets.'

The debates around OPEC tactics will continue, but regional economists will focus their attention on three factors: the dollar/euro exchange rate; the reasons for the dollar's collapse; and forecasts over how far it will fall.

The first is straightforward. So far, the dollar has shed a further 1.3 per cent since the start of the year. The answer to the second question is a study in political economy. As the US advances into election year, the mix of tax cuts, low interest rates, a current account deficit of almost unimaginable proportions and US Treasury Secretary John Snow indicating that the government wants to export its way out of economic trouble, has been enough to throw the dollar off a cliff (see The Last Word, page 40). On the third question - when will the parachute be opened - opinion is divided. Speaking on 10 February, Paul Dubcombe of State Street Global Advisorsshared the results of a survey of eight major foreign exchange banks. The spread on where the dollar/euro rate would end the year was broad: at one end the analysts forecast a further 10 per cent depreciation; at the other, that the dollar would claw back 6 per cent of its value. The average forecast was that it would end the year almost exactly where it started (see figure 3).

So how will this impact the GCC? First, reduced purchasing power of non-dollar denominated goods and services will continue. Assuming that nominal oil revenues will not rise to compensate - dollar oil prices may be defended, but not at last year's production levels - there will be real fiscal deterioration across the region, even before the impact of increased spending plans. Given the recent fiscal strength, the marginal retreat will be easily managed.

Second, the higher comparative cost of imports from non-dollar-linked Asian markets and Europe will have a significant inflationary impact on regional economies, and it will be felt hard this year as stocks are rotated. Given the paucity of reliable historic inflation data, and the reluctance of some governments to acknowledge the phenomenon, the increase may pass unnoticed in the official statistics. But it will be felt and it will be troublesome.

Third, regional governments will have to combat this inflationary pressure with one hand tied behind their backs. In practical terms, the direct pegging of local currencies to the dollar limits the ability to move local interest rates too far from a narrow spread above the US Federal Reserve's benchmark. As figure 4 illustrates, US rates are - by any measure - at historic lows. Over the last couple of years, their repeated slashing by Alan Greenspan has - accidentally - contributed to the resurgence of non-oil GDP in the GCC. However, as figure 5 makes clear, the inversion of the spread between the Fed effective rate and the European Central Bank (ECB) rate has been dramatic and, arguably, unsustainable. The correction will come - probably not before 2005 - and when it does, the higher cost of borrowing could act as a painful brake on non-oil economic expansion in the region, particularly on the private sector. The benefits for those who hedge effectively will be significant.

The perfect macroeconomic calm may not be about to turn into a perfect storm, but the region should be preparing for a rougher ride. Of course, the key questions are over when the unravelling will start, and whether real progress on economic reform programmes will help to cushion the landing. n