UAE Central Bank Holds its Ground Despite the Shaky US dollar peg

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The UAE central bank released a statement in July about how its interests may be determined by the US debt crisis.

The country pegs its currency, the dirham, to the dollar, which means it controls its value in relation to the value of the dollar.

It doesnt hold any treasury bonds or government financial instruments with the US. Neither does the bank see a risk in investing in US treasuries, as per the statement of Mohammed Al Tamimi, deputy executive director of the central bank of UAE.

Therefore, the central bank sees no credit risk and although the downgrade gives a grim outlook the UAE plans to keep its US dollar peg.

Imports Effected

Standard and Poor (S&P) , an organization that rates, benchmarks and analyzes the status of various markets and economies, cut the US credit rating bring it down to AA plus last week. And to the countrys dismay it is likely that another downgrade me occur in 12 to 18 months due to the countrys rising debt and budget deficits.

UAE is heavily dependent on imports, and this would be affected by the weaker states of the US dollar.

With regards to retail, Yusuffali, one of the board of directors of Abu Dhabi Chambers said that the, weakening of US dollar might trigger imports cost, which will affect price of commodities and food, especially those imported from the Europe.

UAE – US bond

The UAE is the largest export market for the US, in the Middle East region within an average of $11.6 billion in exports annually. The former buys products for almost every state.

Taking this strong commercial relationship into consideration, it was foreseeable that should either country be caught in an economically problematic situation, they would not be too quick to make drastic changes in the relationship.

However, taking the same points into account, the dollars depreciating value can make it a less sustainable currency for the dirham to be pegged to.

Effect beyond Oil Industry

The long term prospects for the dollar look quite troublesome according to analysts. This may lead to a higher imported inflation within the Gulf regions.

The global slowdown will have a wider effect than only lowering oil demand.

Slower global growth would have a negative impact on non-oil trade. Tourism, retail and investment could also be negatively affected as consumer demand is likely to weaken In 2006 until H1-2008, GCC currencies experienced strong pressures to revalue against the dollar. Inflation was high, asset prices were rising out of control and liquidity was exploding, Marios Maratheftis, an economist with Standard Chartered, said.

Along with the possibility of higher imported inflation in the Gulf region, for the UAE, the declining rents will likely offset some rise in commodity prices and other imported inflation.

Possible Changes

When asked about how the dirham peg to US dollar will change, leading importers interviewed by Khaleej times stated that this equation will not change so quickly. As per the suggestion of Rizwan Sajan, Chairman of Dubai-based Danube Building Materials, the UAE may need to move into a multipolar system and the idea of having a unified GCC currency may have to be revisited.

From the statement of the central bank, it is quite clear, though it is not too wary about the current situation in the US. But is the central bank being naive? In time, perhaps as the impact of the change begins to surface, it may have a clearer idea on what action must be taken.

Sources: Dubai Chronicle, Khaleej Times, Gulf News

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