Revaluation is only a matter of time

The UAE central bank may have eased a chronic shortage of US dollars by allowing local banks to borrow up to $200 million (Dh734m) per day. But the economic forces building up behind a revaluation are so strong that this can only be a postponement of the inevitable, and the Emirates will probably not move until Saudi Arabia takes a decision to revalue.

The word from the Kingdom, the biggest economy in the region and a hugely important trading partner of the UAE, is that the riyal will not be revalued or depegged until the end of 2009. And it has to be said inflationary pressures in Saudi Arabia are growing but they are not nearly as pressing as in the UAE, so that deadline could be moved forward but not by much.

No lesser figure than Alan Greenspan, the former chairman of the Federal Reserve, told an audience in Abu Dhabi recently that revaluation was an ideal solution for a one-off hit to inflation. Indeed, it is hard to think of a single economist who argues that revaluation would be bad for the regional economy.

The opponents lie in the sovereign wealth funds. The custodians of the region’s wealth do their accounting in US dollars, and do not relish seeing their funds reduced by three to 20 per cent in local currency terms by revaluation.

Some wealthy local families must feel the same way, but only those who have the majority of their assets held outside the GCC, a diminishing band in these days of high domestic investment.

However, the economic forces that have brought revaluation to the top of the agenda are not about to go away anytime soon. The dirham is pegged to the dollar, which is sinking as the US economy is mired in a recession, financial crisis and real estate crash.

Pundits are now arguing over how long the American recession will last and just how low the dollar will go.

Certainly interest rates will be heading lower before they can come back up, and this is a downward pressure on the value of the dollar. On the other hand, a US stock market crash might help to rally the greenback, or the European Central Bank could take decisive action, although it appears about as inflexible as the GCC central banks.

There was some contrarian thought at the start of the year that suggested that the dollar had fallen so far it could not go any further. Perhaps a more obvious conclusion was that a falling dollar would carry on falling. Famous gold bug Jim Sinclair has pencilled in $1.64 to the euro as a short-term target, and his forecasting record in the 2000s has been spot on.

At some point then the pressure on the GCC central banks to revalue will become inexorable. Inflation is already spiking higher, and measures to cap local food costs are terribly unfair to suppliers and will result in shortages of key commodities in the shops.
 
Interfering with market forces of supply and demand will create more problems than it solves. Did we learn nothing from the collapse of the communist bloc?

Raising salaries is another solution suggested by those with limited knowledge of how economics works. Higher salaries automatically translate into higher inflation. Remember Britain in the 1970s and the trade unions?

This will make inflation worse and not better, and is particularly hard on those with fixed incomes who are also liable to become a social problem.

So while we may now have to wait until the end of next year for the obvious to become the chosen national policy, revaluation is going to happen. UAE residents are therefore best advised to continue holding their cash in dirhams.

Inflation will be even stronger by then because the central banks have sat on their hands and ignored the well meant advice of Alan Greenspan. And that will mean that the revaluation will have to be even bigger than expected.

However, there will at least be time for a rumoured new Federal Monetary Policy Committee to be properly set up to plan this change in the UAE foreign exchange policy in detail. News agency Zawya Dow Jones reported that it will be headed by Saif Al Shamsi, head of treasury at the central bank.

In the meantime, local savers are not likely to want to hold dollars in case a revaluation decision is suddenly sprung upon them, and usually central banks like to catch people unaware to outwit the speculators.

That means local banks may well have to call on the new $200m a day dollar facility to maintain liquidity as it will not come from depositors.But those expecting a revaluation are not expected to be disappointed in the medium term.

History is littered with examples of central banks held hostage by economic circumstances and ultimately forced to capitulate with attendant embarrassment. Sadly the wait is also always accompanied by real and largely avoidable damage to the local economy.