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Mon 4 Feb 2008 06:20 PM

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Inflation threatens to derail monetary union

GCC states will have to revalue to rein in inflation and meet 2010 deadline, DCCI warns.

Soaring inflation across the GCC is threatening to derail the block's plans to establish a monetary union and single currency by 2010, Dubai Chamber of Commerce and Industry (DCCI) warned on Monday.

The DCCI said GCC member states have so far been unable to meet inflation criteria required for the monetary union, and the situation is becoming more difficult as housing supply shortages and the rising cost of imports linked to their currencies' peg to the tumbling US dollar fuels inflationary pressure.

The criteria states that inflation rates are not allowed to exceed 2% of the lowest three's average.

Of the six member states, Bahrain has the lowest inflation rate, at around 3% last year, while Qatar has the highest level of inflation at an average of 14% last year.

However, all six are struggling to rein in inflation, with investment back Merrill Lynch predicting last week inflation will continue to rise across the Gulf this year, hitting a 20-year high of 12% in the UAE.

RELATED: UAE inflation in danger of hitting 12% this year

The DCCI said that given Gulf leaders' determination to establish a monetary union by 2010, something most analysts now think is impossible, central banks will be forced to revalue their dollar-pegged currencies in order to harmonise inflation rates.

"It is therefore most likely that the UAE Central Bank will revalue the dirham against the US dollar inline with other GCC currencies," the DCCI said an economic bulletin.

"This will help to some extent in alleviating inflationary pressure whilst retaining adherence to the dollar peg stipulated as an integral part of the convergence criteria necessary for a MU (monetary union) in 2010."

Record inflation has seen increasing pressure heaped on central banks to revalue their currencies or follow Kuwait's lead and ditch the dollar peg altogether.

Kuwait broke ranks with its neighbours in May last year and dropped the dinar's peg to the dollar in favour of a basket of currencies, citing the US currencies' falling value as driving up inflation.

Egyptian investment bank EFG-Hermes has forecast a 60% likelihood that central banks will introduce currency reform this year.

However, central banks have repeatedly ruled out any monetary policy shift.

In the latest defence of monetary policy, Oman Central Bank Governor Hamood Sangour Al-Zadjali on Saturday ruled out revaluing its currency or dropping its peg to the dollar, saying a weaker rial helps attract foreign investment and make exports more competitive, offsetting inflation.

RELATED: Oman rules out depegging, single currency

Al-Zadjali also ruled out altogether joining the monetary union by 2010, reiterating a decision Oman took in 2006 over concerns that spending targets could constrain economic growth.

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