M.E.Times - 18/5/2006

Kuwait's decision to revalue its dollar-pegged dinar by 1 percent last week has sparked a debate among economists about whether or not the United Arab Emirates (UAE) should follow in its neighbor's footsteps to control growing inflation.

Proponents of such a move say that currency revaluation would be sensible, especially at a time when officials are preoccupied with inflation and the means to curb it. They argue that if the Emirati dirham were to be appreciated against the dollar, imports would become cheaper and exports, primarily oil, would become more expensive.

"In the context of the current economic conditions in the region and the weak long term outlook of the dollar, it makes sense for many of these countries to revalue their currencies against the dollar," the Khaleej Times daily quoted the treasury head of a foreign bank in Dubai as saying.

"Something between a two to five percent revaluation would be appropriate especially now when there are strong inflows on both the current and capital accounts," agrees Hani Genena, a Cairo-based economist with the brokerage firm EFG-Hermes.

While the dirham is currently pegged to the dollar, it floats against all other currencies. Although it does not affect the price of goods bought from the US, the weakening of the dollar has increased import costs from the European Union, for example, by about 3 percent since the beginning of the year.

Most consumer goods in the UAE are imported. In 2004, 32 percent of imports came from the EU, 10 percent from China, 9 percent from India, 6.8 percent from Japan and 6 percent from the US.

While officials say that inflation in the UAE had reached about 6 percent in 2005, independent economists say that it had actually rocketed up to 15 percent.

Officials admit that the dollar's decline is fueling further inflation in the UAE, but the central bank has declined to say whether a dirham revaluation is in the pipelines.

Abdullah Bin Ahmed Al Saleh, an economy ministry undersecretary, told reporters this week that the rising cost of non-dollar imports will continue to affect inflation this year.

"There is an impact for sure ... This is not only a problem for us; it is a problem for the US as well," Saleh said, adding that the government was in the process of introducing new laws to encourage competition to help control inflation.

"We are working toward changing the competition law and [creating] a new companies law to allow for more competition," he said.

In the meantime, some bankers are recommending that the UAE shift 10 percent of its foreign currency reserves into euros in light of its significant trade volume with Europe and as a means to protect dollar-pegged reserves against further dollar fluctuations.

For its part, the UAE Central Bank has again given no leads as to whether or not it is considering shifting its reserve holdings in favor of the euro.

"It makes perfect immense economic sense for the central banks [of the Gulf] to revalue their currencies and diversify their reserves in the context of the declining dollar," a forex dealer with an international bank was quoted by a local paper as saying. "In fact the dollar peg which all the Gulf countries follow can become a liability in the context of a projected long term in the dollar," he added.

But these calls for ditching the dollar have also been resisted by some dollar loyalists who insist that the currency peg has served the UAE for over two decades and that the current decline in the dollar is not severe enough to warrant a monetary policy change.

"I don't think our currency is undervalued considering our economy, and I don't think a revaluation is the best way of addressing a trade surplus," says Abdullah Sharafi, executive director of Gerab Enterprises, an oil equipment trading firm.

He said that companies can instead hedge prices against currency fluctuations and ask suppliers to quote prices in dollars, even if it means adding costs.

But calls for change remain louder as economists are warning against grave consequences for the UAE's economy if the government does not ask fast.

"This cannot wait ... the authorities need a cunning plan to boost the currency," says the Gulf News daily. "If nothing is done, this otherwise successful economy may be blown off course by storm-force international winds. In these waters, the UAE needs to consider changing track."