Currency wars put dollar peg back in focus

Top economist recommends that the country re-evaluate its monetary policies, but dirham will stay tied to greenback.

A leading global financial think tank yesterday recommended a co-ordinated currency adjustment for the UAE and its Gulf neighbours. But the Government repeated its pledge to retain the dirham's peg to the US dollar.

The Central Bank was not considering ending the link to the weak greenback as inflation was low, said Saif al Shamsi, the executive director of the regulator's Treasury Department.

"At this moment and this time we are not considering that (de-pegging)," Mr al Shamsi said yesterday. "Oil is priced with the dollar and more than 50 per cent of our trade partners are dollar-related."

The dollar is expected to remain relatively weak in the medium-term as the US embarks on a second round of quantitative easing (QE) to revive its economy. Fluctuations in the greenback's value have implications for the GCC, with five of the six economies linking their currencies to the US dollar.

Some economists have urged the region to review fixed exchange rates as they recover from the global financial crisis at their own pace. Such a move may enable the region greater flexibility to fine-tune economic growth and guard against the risk of a return of inflationary problems.

Phil Suttle, the deputy managing director and chief economist of the Institute of International Finance (IIF) in Washington, said a revaluation in currency pegs should be done in concert with other emerging economies.

"If I were the UAE I'd be trying to co-ordinate first with the GCC and then as an economic bloc with Asia, and advocating doing an adjustment at a measured pace within emerging markets," Mr Suttle said.

"One of the benefits to this would be emerging market asset prices would find an equilibrium."

The dollar's recent decline has led to concerns about the region's vulnerability to inflationary pressures due to higher import costs for commodities such as food. Inflation in the UAE reached a 16-month high of 1.2 per cent in September.

The dollar peg means regional policymakers have limited room to exercise independent monetary policy tools to control inflation in asset prices. Their action has to closely follow the responses of the US Federal Reserve, which is maintaining low interest rates.

The US President Barack Obama yesterday defended the Fed's policy of printing money after criticism from China that it risked sucking potentially destabilising inflows of money into emerging markets.

Both countries have been locked in a currency dispute in recent months, with each accusing the other of undervaluing their currencies to boost exports.

The fallout has also affected other countries, with Brazil complaining that an appreciation of its own currency has harmed the competitiveness of its exports.

Kuwait is the only member of the GCC that has moved away from a fixed link to the dollar. In 2007, it pegged its dinar to a basket of international currencies, heavily weighted in dollars but also including the euro.

The basket has helped Kuwait weather the turmoil in global currency baskets, said Waleed al Awadhi, the deputy manager of supervision and policy affairs at the Central Bank of Kuwait.

"It's advantageous and reflects and helps provide stability," Mr al Awadhi said.

The next step for regional currencies would be moving towards a regional single currency, initially either pegged to the US dollar or a basket of currencies, he said.

The UAE pulled out of plans for the GCC monetary union in May last year.

Speculation about a revaluation of the UAE dollar peg last emerged in 2007. Then a flood of speculative money into the region stoked double-digit inflation and a housing bubble as investors brought in funds expecting local currencies to be revalued.

The revaluation did not happen and the financial crisis sparked a sudden outflow of money, exacerbating a credit crunch in the country.