The UAE Central Bank’s decision to cut interest rates in tandem with the US Federal Reserve has increased demands for a revaluation of the dollar-pegged dirham to avoid stoking inflation.
The Central Bank has repeatedly said it will not revalue – but some bankers yesterday said a revaluation was inevitable to strengthen the dirham against other currencies. Economic experts said the value of the dirham should be increased gradually to limit inflation and warned that reducing interest rates would increase inflationary pressure on the UAE economy.
They insisted that interest rates cuts totally contradicted the current economic cycle in the UAE and the Gulf co-operation Council (GCC) region.
Jamal Saleh, Head of Risk Management at the Commercial Bank of Dubai, said: “The Central Bank insisted it had no intention of revaluing the dirham after speculators and investors took pre-emptive action to benefit from an expected revaluation. But expectations are built on economic studies and the monetary authorities should act to limit inflation. Revaluation will play a major role in controlling inflation.”
Ziad Dabbas, a financial consultant at the National Bank of Abu Dhabi, said: “Interest rates cuts in the region will stoke inflation, which is already at a high rate, particularly in the UAE and Qatar.
“Monetary policy-makers in the region are in a critical situation. They had to cut interest rates to limit speculation on regional currencies while the economy needs increased interest rates to control inflation.”
And Ezzeldine Al Masri, Senior Vice-President of the Union National Bank, said: “I think inflation will continue its upward drive but interest rates are only one factor. The most important reason is the gap between supply and demand. The supply of money and liquidity surged and the supply of services and commodities could not match the demand.”
Fadi Al Saeed, Director of Asset Management at Emirates-NBD, agreed the interest rate cuts increased the challenges facing GCC central banks to limit inflation.
He added: “We do not have active government bonds markets or derivative tools to counter inflation, which has become a major threat to economic growth. Current monetary policies push inflation higher.”
Nadine Wehbe, a senior market analyst at Orion Brokers, said lower interest rates meant more debt, which gave purchasing power a boost and led to higher spending and eventually higher inflation levels.
The US Federal Reserve’s 0.75 per cent cut exposed real fears of a recession in the world’s largest economy, said experts. The decision reflected the seriousness of the situation in the equity and credit markets as well as the deterioration in macroeconomic data.
Dabbas added: “The emergency cut was a surprise to the markets. It came ahead of the Federal Open Market Committee meeting and was the biggest single reduction in US interest rates for more than two decades.
“The US economy is suffering from heavy pressures, especially the sub-prime crisis and the recent massive losses reported by major banks. The US interest cut was the right and immediate action to solve problems in the US economy – but the situation is different in GCC countries, especially the UAE. The situation is very complicated.
Any recession in the US economy will harm oil prices, the main source of income and liquidity in GCC states. The oil prices has dropped below $86 per barrel and this will affect the gross domestic products of countries in the region. GCC countries have large deposits in the international markets, mostly valued in the dollar, and the interest rate cuts will affect their profits.”
Al Saeed agreed that GCC countries were investing heavily in international markets. UAE investments are estimated at between $600 billion and $800 billion and the revaluation of the dirham would lead to losses in the value of these investments, he said.
Al Masri added: “Interest cuts help corporates to borrow funds at lower rates to expand their businesses and create new projects.
This will in turn lead to increased profits. Some stocks may be overvalued but the current restrictions in credit policies will help prevent major overvalues because companies are expected to achieve further profits.”
He said the most negative impact would be on the currency markets as investors would switch from the dollar to stronger and more stable currencies – and this would further deplete the dollar’s value. But he said the lower value of the US currency would have a positive impact on foreign investments in the UAE.
“When the value of the dollar decreases the value of the dirham will fellow suit. This will attract foreign investors to the country and this will support economic growth.”
UAE investments in international markets are estimated to be between $600bn and $800bn and the revaluation in the dirham would lead to losses in these investments, says Al Saeed
Interest rate cut leads to renewed call to depeg