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UAE waits for Saudi signal on revaluation

United Arab Emirates: Tuesday, January 29 - 2008 @ 14:31

What hastened the consideration of the dollar-peg and revaluation – apart from mounting inflation – was probably the surprise interest rate cut by the US Federal Reserve last week which weakened the dollar again, and through the dollar-peg all the Gulf currencies.

The idiocy of having the interest rates of the booming GCC economies set at a wholly inappropriate level by the slowing US economy is clear once again for all to see.

Lest we forget low interest rates are an economic stimulus, and cause further inflation in already booming economies. In the GCC states, revenues are in dollars while imports are largely priced in non-dollar currencies, and therefore a weaker dollar causes an instant inflation of import prices.

De-pegging

However, it is not necessary to keep a dollar-peg fixed at a certain rate of exchange forever. When local economic policy considerations dictate then it is relatively simple to revalue in a rare, one-off action.

The benefit to the domestic economy is immediate in hitting inflation, unless the US dollar weakens further as a result and then the effect is cancelled out. However, Gulf currencies play nothing like the role of the euro or yen in the global economy and this is unlikely.

The biggest negative impact is in the re-pricing of assets held overseas in local currency terms. But by the same token assets held in the GCC will be worth more in dollars, and this asset price revaluation differential should cancel out.

However, with the Federal Reserve now clearly in interest rate cutting mode the time for action in the GCC is more urgent than ever. It could be that US interest rates plummet to one per cent as seen during the dot-com crash, and that the dollar weakens again.

New monetary regime

What is really needed in the GCC is a new monetary regime with a single currency set against a basket of currencies and interest rates that are appropriate to the domestic economy. Revaluation should be seen as the first step along this road and accompanied by a phased move towards a GCC single currency, which likely means the end of the peg.

The UAE and smaller Gulf states are bound to look to Saudi Arabia for a lead and the deliberations of the Shura council will be closely watched for clues about the way forward.

It could be that a compromise solution emerges with an immediate 5-10 per cent revaluation and retention of the peg until a newly appointed committee comes up with a viable alternative. But it does not do to try to second guess the Shura council.

See also:
Saudi sovereign fund could be global leader

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Tuesday, January 29- 2008 @ 14:31 UAE local time (GMT+4) Replication or redistribution in whole or in part is expressly prohibited without the prior written consent of Mediaquest FZ LLC.

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