The currency markets remained gyratory during 2004, as euro has to place its firm position in the market.

The re-election of Bush put further pressure on the dollar, as the investors get worried about the burgeoning US current account deficit, which is now mounting to six per cent of GDP.

Investors believe that the spendthrift President would continue with his extravagant policies, which would further dampen the strength of dollar in international markets.

The dollar has lost its value by over 28 per cent against index of major currency since early 2002. The dollar depreciated between 1 Jan 02 and 30 December, 2004 by 52.09 per cent against the euro, 21.64 per cent against Yen and 31.75 per cent against Pound Sterling.

The annualized depreciation during the last three years is calculated at 15, 7.8 and 9.6 per cent against euro, yen and pound sterling respectively. Currently the losing streak is continuing against all major currencies and the expectations are that it will further lose its value during 2005.

As long as the dollar remained strong in the international markets, it has been serving the interests of oil producing nations, as their black gold, which earns them most part of their revenues, is priced in dollar.

A strong dollar helped them in stabilizing fluctuations in their financial wealth and had covered the exchange rate risk. But since January' 02 as it started weakening against key currencies, hurting the interest of the oil producers, mainly GCC countries that have pegged their currencies to dollar.

Dollar depreciation has proven a hidden tax on their revenues as their purchasing power has reduced significantly. For their imports from Europe alone they have to pay 52 per cent more than what they paid in 2001. Other major imports to these countries are from Japan that is also proving expensive for them.

The recent hike in the oil prices remained the focus of a number of analysts and the OPEC was generally blamed for the price hike. However, the oil prices as they are translated in Dollar appear to be significantly higher in nominal terms.

However, in terms of other currencies the price increase was modest, given the demand supply situation of the oil market. The oil price trend after adjusting for dollar depreciation against the trade weighted index shows (See the chart) that the prices were only high for a short period of two to three months; otherwise the prices were in line with the price trend witnessed during 2000.

The trade-weighted index of dollar is not the right measure for adjusting the oil prices, as Fed allocates its weights based on its trade relations with their trading partners of US.

The ideal index should include the trade weights of the trading partners of the oil producing nations, which is heavily weighted toward, European and Asian countries. However due to paucity of data constructing such an index is not possible.

The continuity of dollar depreciation has raised the question in the minds of oil producing countries 'if the dollar is still serving their purpose?' Under above analysis, it seems that it is hurting more than protecting the interest of oil countries.

In addition, the dollar depreciation was itself behind the increase in the demand for oil and the reduced supply during 2004, as the users have to pay relatively less for each barrel of crude so they demanded more while producers were getting lesser so they reduced the supply.

Last year when dollar was depreciated massively against key currencies, the OPEC was thinking to incorporate dollar depreciation into their pricing policy, which was not undertaken later.

The recent slide in the dollar has reignited the debate and the Opec is now seriously rethinking to increase the price band form current $22-$28 to new $30-$35. Some implicit actions have been seen when the Opec cut its supply when the oil price for OPEC basket of crudes came down less than SR35 in early Dec.'04.

The question is 'if this is a viable policy to increase the price band?' as it may hurt the interests of some of the trading partners of the oil producing nations.

An unsolved riddle in the world financial markets is 'if the dollar loss its faith as reserve currency, would there be any currency to replace it?' Euro is not mature enough to become a reserve currency, though central banks across the world are diversifying their reserves from dollar to include euro in their portfolios.

The long-term growth prospects of Europe are not as bright as US, while EU is also facing other political problems and switching from dollar to euro may result in a rather more volatile currency markets.

Yen on the other end is not a viable option as the Japan is facing its own problem of aging population, low birth rates and sluggish growth in the recent past.

Later in medium term, China may become a power symbol and the Chinese yuan may emerge as another international reserve currency but that time is still years ahead. Only ancient rival for dollar is gold, which carries its own merits and demerits.

Given these scenarios, if the private investors retreat from dollar, as the data shows that foreign capital flow from private investor is now edging downward, then international governments will most likely to intervene to bail out any crisis by purchasing dollar as this would also be equally important for their own economies and the currency market would be driven more on political grounds than on economic fundamentals.

Under such scenarios, continuity to price oil in dollar is needed at least in short to medium term. To bring stability in the oil revenues certain formula is mandatory, both to bring about financial security to oil producers and smooth flow of oil at reasonable price to the world to avoid any oil shock.

Revising price band after a period like four years is itself not an ultimate solution, especially under highly volatile currency and oil markets. It is only the recent oil shock that made OPEC to think of increasing the price band and the consumers are also willing to afford the pricey oil.

This is probably the right time to devise certain pricing formula with the long-term objectives of stability and affordability both for the oil producers and consumers. A more viable solution for the Opec could be to index the price of crude to the basket of currencies on the trade weighted basis.

The said reference basket of currencies could serve an indicator and the crude can continue to be priced in the dollar or it can be priced in more than one currency for different trading partners with the objective of diversifying the reserves.

This solution can help the GCC countries to link their common currency with the basket of currencies once they will achieve full monetary union in 2010 in addition to better economic and political ties with trading partners.

Another solution is to frequently adjust the price band to the inflation and dollar depreciation to safeguard the interests of oil producing nations. This will increase the stability of the oil revenues for the oil producing countries, and would ensure investments in upstream and downstream operations and hence smooth oil supply.

(The author is a Riyadh based economist at Economic and Equity Research department of The Consulting Centre for Finance and Investment, Saudi Arabia).