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26 February 2024

Free float of dirham poses economic risks

By Mohamad Al Kady



UAE bankers and financial experts rejected Alan Greenspan’s suggestion to the GCC states to allow their currencies to float freely, citing political and economic reasons that pushed decision makers to continue the dirham-dollar peg.

They also highlighted monetary obstacles that prevent the free float of GCC currencies, especially the shortage in financial and technical abilities of monetary authorities to control this process.

Former chairman of US Federal Reserve Alan Greenspan has advised the UAE and other GCC countries to free float their currencies to ward off the impact of rising inflation.

“I think free floating is better than fixing or revaluation against the flagging dollar,” Greenspan told the Abu Dhabi Corporate Leadership Forum on Monday.

However, Ziad Dabbas, financial consultant of the National Bank of Abu Dhabi, told Emirates Business that the monetary policy is political rather than economic decision in the case of GCC countries including the UAE. “Most of GCC governments carried out detailed studies, in co-operation with international institutions, on positives and negatives of de-pegging with the dollar and they found that it is in the interest of the region to keep the peg with the dollar.”

Dabbas said that UAE’s study showed that the dirham is undervalued by more than 20 per cent. “But to take a decision to depeg the dirham from the dollar, revaluate the dirham or let the dirham float freely, is a political decision because oil revenues are major part of the country’s income and changing the dirham value means a drop in the GDP.”

He added that the political impact on the issue is very clear in three main factors. “There is a strong connection between Federal Reserves, interest rates and central banks in the region. Also all official statements ruled out the possibility of dirham revaluation or depegging with the dollar. And finally, there is a clear downturn in speculations on the dirham among currency traders.

“The main reason behind proposals to revaluate the dirham or allowing it to float is the depleting value of the dollar and the increasing inflation rates. For the dollar value, there are high expectations that the dollar will start an upward trend by the end of 2008 so revaluating the dirham would be meaningless,” Dabbas said.

He added that the depleting dollar value has a marginal impact on current inflation rates in the UAE. “Local factors are the main drivers of inflation because the rising accommodation rents and property prices represent 40 per cent of inflation in the country.”

Jamal Saleh, head of asset management at Commercial Bank of Dubai, also agreed that allowing the dirham to float freely is unlikely.
“Letting any currency to float needs strong monetary policies by monetary authorities to control levels of liquidity and reserves. It is very difficult in GCC economies that depend on revenues of one product [crude oil] which is priced in dollar.”

Saleh said allowing the dirham to float would impose high risks on the economy, and the same for other GCC countries. “There are risks on the value of oil revenues, which are the main driver of current economic progress in the region. Also GCC countries have intensive international investments, mostly estimated in dollars, and re-evaluation of currencies means reducing the value of investments.”

Sherif Sanad, institutional desk manager at GFS Investments, a currency exchange brokerage, said that inflation rates in the GCC region, especially the UAE and Qatar, recorded high rates and de-peging the dirham from the dollar would decrease these rates. “After Kuwait severed dinar peg with the dollar in May last year, inflation rates began to drop.”

He added that depegging is one of the solutions but it should not be considered as the ultimate solution for inflation in the Gulf.

“The GCC states should start pegging with basket of currencies and it is highly recommended to peg with currencies that all of the GCC are importing from.”

He cited reports last year that the majority of the GCC imports came from Asia and Europe. “Statistics showed that 40 per cent of GCC imports came from Asia and 40 per cent came from Europe.”