The governor

In the boardroom of the Central Bank of the UAE, Sara Hamdan discusses currency pegs, inflation and works of art with Sultan Bin Nasser Al Suwaidi, the man with all the answers.

Daggers hang on the wall of the UAE Central Bank boardroom. The governor may be excused for thinking a few of them have been pointing towards him these past six months, as the chief guardian of the country's economy has come under repeated pressure to drop the currency peg to the ailing US dollar.
It is a question that has dominated the regional financial press for more than a year as the UAE and its Gulf neighbours have struggled to cope with record inflation without the ability to independently set interest rates because of their pegs to the greenback.

It is also the first question that Sultan Bin Nasser Al Suwaidi gets asked by every journalist he comes across, looking to break what would be the economic news story of the year - a definitive decision to drop the peg for a currency basket.

"I think everyone is getting tired of that answer," he says as he trots out the by now well-rehearsed line.

Suwaidi is wise to choose his words carefully. With so much riding on the Gulf's dollar pegged economies, he only has to hint at possible change to move currency markets.

When US Treasury Secretary Henry Paulson said earlier this month that he had been assured Arab Gulf states would maintain their pegs, future contracts to buy dirhams and riyals fell 0.4% against the dollar.

"Misinterpreted remarks about the peg could fuel inflation expectations and make things worse than they are," says Suwaidi. "It would lead to some other structural imbalances in the economy."

Such market sensitivity around the future of the Gulf currencies explains why Suwaidi takes time to reflect before answering questions, and why his responses seem that much more measured.

The Central Bank boardroom is part office, part art gallery. Along with the daggers on the wall there are models of traditional dhows, multi-coloured vases, paintings from China and wooden elephants from India. There are trophies, awards and oil paintings of ruling families everywhere to be seen.

Sitting in the middle of this eclectic collection, Suwaidi explains why he believes the inflationary pressure facing the UAE is more about ‘bricks and mortar' than ‘pegs' and 'baskets'.

While the US economy battles the threat of a recession and a declining dollar, the same policies used by financial authorities to stimulate the US economy are causing prices to skyrocket in the dollar-pegged Gulf nations.

With oil prices soaring and shortages of basic foods such as rice and sugar as well as materials including steel and cement, there are no signs yet that the inflationary pressure being experienced in the region will ease any time soon.

Suwaidi insists that the local real estate market is the root cause of rising prices.

"The first chapter of inflation came from local sources, specifically from real estate and the availability of housing units and office space," says Suwaidi.

"Because of these bottlenecks that have developed in the housing market, prices are jumping," he adds.

The soaring cost of construction has also fuelled the problem, increasing the cost of development and therefore the selling prices sought by real estate companies and the rents needed by landlords.

"When prices go up in the real estate market, everything else goes up because this feeds into everything," he says.

Inflation may have hit 14% in Abu Dhabi last year according to the Abu Dhabi Chamber of Commerce - the highest rate in the region.

The chamber, citing government estimates, reported that inflation skyrocketed last year largely due to rising food, fuel and housing costs in the region, which led to a peak inflation rate of 15% last year.

High inflation rates are typically controlled by monetary policy through increased interest rates; however, the UAE's dollar peg restricts the central bank's ability to implement rate hikes because actions must be linked to those taken by the Federal Reserve in the US, which has cut its benchmark lending rate by 3.25% since September 2007, in a bid to stimulate the economy.

Gulf policymakers, though under pressure to move to a basket of currencies, are holding to a steadfast decision to keep the local currency pegged to the dollar.

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