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Thu 26 Nov 2009 04:00 AM

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Off the peg

Prior to the Lehman collapse, everyone was talking about the dollar peg; now it's back in fashion, says Damian Reilly.

One of the few good things about the global downturn was the change in conversation topic it brought about.

From mid-2006 until the collapse of Lehman Brothers in September 2008, you could hardly get through a meal or passing chat with anyone living in the Gulf without the topic of the dollar peg coming up. Back then, as Gulf economies boomed while the greenback floundered like a broken heavyweight champ, fatted on the spoils of three decades of improbable supercharged success, the general consensus seemed to be that it was time to drop the pilot.

‘The dirham doesn’t need to be pegged to the dollar anymore’, many of us moaned as the domestic inflation rate rose to an official twelve percent (some would say much higher) and the value of money sent home by expatriates each month dwindled, while the cost of goods imported from overseas increased.

Indeed, at about the point in 2007 that one British pound could buy you two US dollars (for the first time since 1992), and you could get 42 Indian rupees to the greenback, Kuwait did break its peg.

Those of us who believed that the UAE was considering doing likewise but didn’t want to act unilaterally amongst the GCC states, thought Kuwait’s move might be the harbinger of a similar decision. Not so. The UAE’s central bank governor when inflation was the biggest issue in the Gulf, His Excellency Sultan Bin Nasser Al Suwaidi, and indeed the other GCC Central Bank heads, remained adamant whenever asked about the future. ‘We are not considering breaking the peg,’ they always said.

And then Lehman went under, the global economy collapsed, house prices and rents in Dubai came tumbling down, and everyone shut up about the peg. Until today, that is. At the time of writing there is a report in The National, no less, that sizeable quantities of money are coming into the UAE on speculation that the UAE is now considering depegging. ‘Hot’ money, it’s being called. The timing seems odd, to put it mildly.

At the beginning of 2008, I interviewed Al Suwaidi. In his cool, oak-panelled office in Abu Dhabi, he explained why the UAE had no intention of depegging, however weak the dollar was getting (at the time), and however high inflation was getting.

Certainly the arguments he made then would seem as valid today. Asked about the whether he would like the US to raise interest rates to curb UAE inflation, he said he didn’t think that would be the solution. In fact, he said: “You have always to prescribe the right medicine for a certain illness, otherwise you will not cure it. We do not believe monetary policy is the right medicine for the inflation.

“Inflation is here because of shortages of housing units and office space, and with that everything is affected. Real estate is like salt in the kitchen: it goes into everything.”

And on the subject of whether the then inflation rate would cool when real estate supply met demand, he said: “It will eliminate inflation, not just cool it down.”

And he has been proved right by 2009.

The National says that investors looking to take money out of low-interest-rate countries such as the US will start investing it in the UAE again in the hope of better returns. Standard Chartered apparently predicts a consequent UAE inflation rate of six percent for 2010. Such a scenario would be a dream for last year’s property buyers in Dubai, who have seen the value of their assets shrink by half. But even if it does transpire, why would we see the dirham depeg in the short term future? The dollar is losing ground to other major currencies, sure, but it is still nowhere near as weak as it was 15 months ago, and the UAE inflation rate is under control. What would be the incentive?

Hot money? Hot air.

Damian Reilly is the editor of Arabian Business English.

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Sandpiper 10 years ago

Given the news about the DW and Nakheel stand still, it is more important than ever for the Dirham to hang on to the peg, if it can...

Simpster 10 years ago

If UAE dirham was depegged now or any time in the near future - it would be sold short and cause chaos in the local market. Stick to the Dollar and stop talking about depegging this will cause more anxiety.

Mounir 10 years ago

Dubai did not default - yet. And if it does; the amount would be in the low billions, not in the trillions as the US and EU economies have had to deal with in the past year. The Dirham is not Dubai's currency alone -- it is the currency of the UAE; a state with 10% of the world's proven oil reserves, along with quite a bit of natural gas. Its the second largest economy in the GCC, and has an SWF fund that is worth anywhere between $350-$800 billion. If Dubai chooses to default; i dont see how it affects the credibility of UAE institutions. People seem to forget that Dubai is part of the same political entity as Abu Dhabi. This is like looking at Quebec and saying that its finances are bad therefore no one should invest in Canada. if thats not retarded, i dont know what is.