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October 30, 2007
Dollar link should be consigned to the sands of time
James Harding, Business Editor, in Dubai

Should the Gulf states depeg from the dollar? This may seem like a
technical question but it is, potentially, the most consequential
economic issue arising from a resurgent Arab world. And, more
importantly, it is live: senior officials in Abu Dhabi and Dubai are
reviewing the dirham's relationship with the dollar.

The financial centres rising out of the sands are all tied to the US
currency. The peg has been a stabilising force, underpinning
investment in what for years has been seen as a region of immature and
uncertain economies. But there are growing arguments for a
revaluation.

Such a decision could further weaken the dollar as hundreds of
billions would likely flow out of dollar-denominated assets. It may
well mean a greater appetite in the Gulf to buy in Europe, not only
strengthening the euro but resulting in more acquisitions of corporate
stakes in the UK. And it would cement the region's transformation from
a petrodollar power into a global hub betting its future on
investment, trade and services.

Kuwait has already abandoned its US currency peg. If any country has
reason to follow suit, it is the United Arab Emirates. For in Abu
Dhabi and Dubai, the two UAE cities competing to be business capital
of the Gulf, there are real pressures to decouple.

There have been demonstrations on the streets of Dubai in recent days
by Indian construction workers who have seen the value of their
dirham-based pay dragged lower by a weakening dollar. A couple of
years ago an Indian worker was sending home 12 rupees for every dirham
earned in the UAE. Today it is only ten. Given that there are more and
more good jobs to be had in India and Pakistan, companies in Dubai are
struggling to find workers.

Inflation is squeezing not only the migrant labour force but also
domestic businesses. The official figures show prices rose by nearly
10 per cent last year and the real figure is probably quite a bit
higher.

Much of the problem, of course, is the result of a booming economy.
Bottlenecks, particularly in housing, have swollen the inflation
numbers.

To make matters worse, the dollar link is forcing them to import
inflation. Dubai and Abu Dhabi buy in almost everything they consume.
Since 2002, they have sourced more and more from Europe, paying for
euro-priced products in a dollar-based currency.

The investment industry is also hemmed in by the peg. As long as the
dirham is twinned with the dollar, there is a disincentive for the big
funds in Dubai and Abu Dhabi to shop anywhere they want for corporate
assets.

There are many reasons to keep the dollar peg. One is that oil is
trading at $92-plus a barrel and this is no time to allow the dirham
to appreciate and forgo a fortune in domestic currency. Another
concern is that a more expensive dirham might put off tourists. A
third issue has been that a depegging has been unlikely while the Gulf
Cooperation Council states have been weighing up the increasingly
unlikely idea of monetary union. And then there is the perennial
argument that the dollar connection reassures foreign investors buying
property in the Gulf.

Like all economic decisions, it comes down to political will. The
temptation will be to err on the side of caution =96 the emirates are
thriving and delinking represents a step into the unknown.

But Dubai and Abu Dhabi are concrete testimony to the rewards to be
gained from breaking old business habits and taking charge of your own
destiny. The UAE should follow its modernising, independent-minded
instincts and change.

--
Yoshie
<http://montages.blogspot.com/>