UAE set to keep dollar peg

The UAE will likely keep a long-standing peg between its currency the dirham and the dollar despite recent weakening of the US greenback and fears that this could fuel inflation in the second largest Arab economy.

In a study published this week, the Saudi American Bank Group (Samba) said the peg means the borrowing costs in the UAE and other Gulf oil producers will remain linked to those in the United States, adding that current low rates would help offset the costs of refinancing debt in the UAE.

“Despite some re-emergence of concerns over the weaker US dollar and its potential inflationary effects through higher import costs in the wake of the US ratings downgrade, we do not expect any change to the UAE’s exchange rate peg to the dollar,” Samba said.

“As a result, US interest rate policy will continue to be the main influence on monetary policy in the UAE. This is thus set to remain loose given the recent statements from the US Federal Open Market Committee that the benchmark Federal Funds rate will remain between 0-0.25 per cent.”

The report echoed statements by UAE central bank governor Sultan bin Nassir al- Suwaidi that the US debt crisis and ensuing slump in the dollar would not affect the country’s monetary policy and that the dirham would remained tied to the dollar despite fears this could stoke inflation again.

But recent government data showed that inflation in the UAE, one of the world’s top 10 oil exporters, remains contained at just 1.3 per cent year-on-year in July.

But according to Samba,inflationary pressures are more apparent than this figure suggests as the headline rate continues to be dampened by price declines in the heavily weighted (40 per cent) housing component of the consumer price index, which was down 2.4 per cent.

Rents have declined by about 40 per cent in Abu Dhabi and 60 per cent in Dubai since their peak through 2008. In contrast food prices (accounting for 14 per cent of the CPI) were up by around 8.4 per cent year-on-year in July, and other items also posted significant increases.

Samba said the weaker US dollar would also have an adverse impact on import costs. “Nonetheless, in light of the first seven months’ trend in the official rate we have revised down our 2011 inflation projection to 1.7 percent, mainly reflecting the impact of sustained weakness in the real estate sector,” it said.

“As for interest, with borrowing costs in the GCC generally linked to US rates, the continuation of low rates should help contain the costs of refinancing UAE debt which remains high…however, CDS rates have recently ticked up as risk aversion has intensified following the US ratings downgrade, and mounting concerns over global growth and Eurozone debt problems.”

The report said this could have some adverse impact on financing costs particularly in Dubai where the cost of insuring against 5 year sovereign loan default has risen back to 369 – albeit still well below the 460 spike prompted by MENA unrest earlier in the year, and the 900 plus prevailing when the Dubai World debt restructuring was first announced in 2009.

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