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Revaluation of UAE dirham back on agenda after surprise Kuwait move

United Arab Emirates: Tuesday, May 22 - 2007 @ 07:56

According to Gulf News internal memos at certain banks are restricting the conversion of more than one million UAE dirhams into US dollars and future commitments. They fear large losses on US currency exposure if the UAE Central Bank revalues the peg against the US dollar.

An advisory note from Standard Chartered Bank now puts the chances of a small revaluation of the UAE dirham this year at 25-30 per cent. For speculators this represents a possible opportunity for instant profits with almost no downside risk of devaluation.

Soaring inflation in Gulf countries mean that low US dollar pegged interest rate levels are now wholly inappropriate, and that local economies are overheating due to capacity constraints and excessive liquidity.

Economic management

A gradual upward revaluation of the UAE dirham would make good economic sense and head off the likelihood of a dramatic boom-to-bust cycle in the event of an oil price decline. It would also provide a one-off currency gain for local real estate investors and help to underpin valuations in the emerging real estate market.

On some estimates the UAE currency is around 30 per cent undervalued in relation to the US dollar, which is a particular burden as most imports are priced in euros and exports in dollars. This has helped to send inflation to 15-20 per cent in the past couple of years.

However, the UAE Central Bank is wary of starting a cycle of revaluations that might get out of hand, attracting more and more speculation in the UAE dirham and large dollar inflows. And UAE Central Bank Governor Sultan bin Nasser Al Suwaidi has recently stated that no unilateral revaluation will be carried out.

But the bank will now be under pressure to make its position clear again in the light of Kuwait’s unilateral decision on Sunday and this might be the best point at which to make such a move, rather than to allow speculation to continue.

Investor bonus

For the UAE stock markets, now picking up after almost two years of sell-offs, revaluation could be a trigger to attract a further inflow of foreign funds looking to cash in on a revaluation bonus. And the same could also be true for real estate in the short term.

But all eyes will be on the Central Bank policy makers. For if revaluation also meant the likelihood of higher domestic interest rates that would dampen economic activity and be depressing for local stocks and real estate.

History in currency markets suggests that prolonging a decision on such major moves just causes more disruption in the long run, and it may well be that the time is right for a revaluation of the UAE dirham, right at the start of the summer season, to give the market a period to digest this change during the quieter months.

On the other hand, the US dollar has strengthened against the euro and pound sterling over the past two weeks, and the UAE Central Bank may choose to do nothing and allow the oversold dollar to correct upwards.

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Tuesday, May 22- 2007 @ 7:56 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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