MIDDLE EAST: Pegging Debate Climbs as Dollar Declines

By IPS Correspondents Reprint | | Print |

Meena Janardhan

DUBAI, Jul 23 2007 (IPS) - As the dollar continues its decline against the sterling, the euro and a host of Asian currencies, central banks in the Middle East are under pressure to consider revaluation of their currencies.

Last week Kuwait allowed its currency to appreciate against the dollar for a second time in two months after the dollar’s slide raised pressure on the domestic inflation and its recently adopted peg against a basket of currencies. Though marginal, the dinar has appreciated 0.77 percent since May 20.

It is unlikely, however, that other Gulf countries will revalue their pegged currencies not only for economic reasons but also for political reasons, heavily influenced by the United States as it is the chief security guarantor in this volatile region.

Gulf countries have kept dollar pegs since the 1980s.

Despite the growing public demand for a revaluation of the dirham, the United Arab Emirates’ (UAE) Central Bank and the government have affirmed that the country will stick to the peg as part of its commitment to the Gulf Cooperation Council (GCC) common currency.

The six-country GCC bloc is planning a single currency by 2010. However, the deadline is in doubt after Oman said a few months ago that it would not be able to meet all the requirements by the target date.

On the ground, the declining dollar is affecting the purchasing power of expatriates. The cost of imported goods is increasing, contributing in some ways to inflation. Further, for every dirham they have been wiring back home for more than a year, the exchange value has seen diminishing returns.

Standard Chartered Bank estimates that 34 percent of imports to the UAE and Kuwait are from the European Union, which has added to the inflation because the dollar has fallen to a new low against the euro.

Simon Williams, economist at HSBC Bank Middle East Limited, says that the dollar has been declining over the past 18 months and GCC consumers are feeling the pinch. ”But, Gulf economies are growing, salaries are rising and so are employment levels. So the direct impact is less serious than it would have been in times of poor economic growth.’’

However, Eckart Woertz of the Gulf Research Centre said, ‘‘It erodes the asset values of GCC countries which hold a majority of their investments in dollars, increases import bill, and erodes the purchasing power of wage earners, especially of expatriates who have payment obligations at home like mortgages, life insurance, etc., in non-dollar currencies.’’

Woertz explained to IPS : ‘‘Expatriates are the worst hit. They are particularly exposed to local price hikes, especially since they don’t own real estate, and also face diminishing exchange rates when they wire money back home.’’

Ahmed Refat, an Egyptian expatriate, told IPS that ‘‘a dirham no longer buys the same amount of goods and services not only in the UAE but also for those holidaying abroad, not to mention remittances. Wonder if this is a short- or long-term phenomenon?’’

Williams had another opinion. ‘‘One must not overstate the impact on expatriates since the Gulf countries are still very good places to be in with employment and salary levels on the rise,’’ he told the IPS.

Rising Asian currencies are also a source of concern for the region as Asia accounts for more than 40 percent of imports into the region. It is estimated that since the beginning of 2007, nearly 50 of the world’s currencies have risen against the dollar.

Analysts say that all the GCC currencies are undervalued by 15 to 25 percent. They feel the dollar is likely to decline due to robust economic performance by the euro zone, higher inflation in the United Kingdom and an expected hike in interest rates.

In March 2006, anger over the decision by the U.S. to block Dubai Ports World from buying five American ports led several central banks in the region to announce that they were considering switching reserves to euros. The UAE said it was planning to move one-tenth of its dollar reserves to euros.

Though a Reuters poll in March this year tipped the UAE as the country most likely to revalue its currency after Kuwait, UAE Central Bank governor Sultan Nasser Al-Suwaidi said in June that the dirham’s peg to the dollar was an anchor of stability for the economy.

‘‘The UAE is benefiting from a weaker dollar as it makes the country a cheaper tourist destination while making exports from UAE very competitive,’’ Al-Suwaidi told the media in June.

Explaining the issue, Williams said, ‘‘Kuwait’s move cannot have much impact on inflation as the revaluation is very small and not enough to make a significant difference on either the sent-home or on local prices. If the UAE wants to do the same, the revaluation will have to be significantly larger to make an impact though it could have negative consequences, like increase in prices of non-oil exports.’’

‘‘Kuwait’s dinar is still pegged by 70-80 percent to the dollar and as inflation is mainly homemade, revaluing will not solve the problem,’’ Woertz said. ‘‘Since it has withdrawn unilaterally it has further damaged the prospects of a unified GCC currency.’’

‘‘A common currency could stand its ground on international markets more easily and would offer new room to manoeuvre in terms of interest rate policy in case the new currency should be free floating at a later stage,’’ he added. ‘‘There is a rationale to move away from the dollar but it should be done by all the GCC countries together.’’