Dollar peg at the crossroads

Dollar peg at the crossroads
By Babu Das AugustineBanking Editor
Published in Gulfnews: November 14, 2007, 00:18


Dubai: The UAE Central Bank Governor yesterday hinted at a potential change in the UAE's exchange rate policy currently anchored on fixed peg against the US dollar.
"The dirham's peg to the US dollar has served the economy of the UAE very well in the past. However, we have reached the crossroads now with a further deterioration in the US dollar and expected further weakening of the US economy," Reuters quoted Sultan Bin Nasser Al Suwaidi as saying in Tokyo yesterday.

Analysts saw the statement as a clear shift in central bank's stand on the peg.
"The increasing frustration with the decline of dollar and domestic inflation could lead to a more flexible exchange rate policy including a move to a currency basket," Monica Malek, an economist with EFG Hermes, told Gulf News.

The sharp decline in the exchange rate of dirham against most leading international currencies have resulted dirham losing its value in the range of 16 per cent and 20 per cent against currencies such as sterling, rupee and euro during the past two years.

While the decline in exchange rates and domestic inflation above 9 per cent is wiping out a significant share of expatriates' earnings, the reduced purchasing power of dirham has also fuelled higher inflation through rising import costs.
Despite this, the UAE was forced to cut interest rates by 0.6 per cent this year following the US interest rate cuts of 0.75 per cent, fuelling further inflation.
"We continue to hold a long dirham and Kuwaiti dinar versus short dollar in our discretionary portfolio," said Emma Lawson, a currency strategist with Merrill Lynch.
Simon Williams, an economist with HSBC, told Gulf News that although the governor's statement is a bold one, a unilateral decision by the UAE is unlikely.

The GCC heads of state are set to meet next month where a collective decision is expected. EFG's Malek said the UAE is clearly the next in line for currency reforms and sees a probability of more than 40 per cent in the second half of 2008.