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Dubai: The economy’s love-hate relationship with the currency peg has been an ongoing saga for the past three decades.
The arguments for and against the peg remain the same, despite a few cycles of inflation. However, calls for a new currency regime have increased in recent years.
The dirham was tracking the dollar since 1978. In 1997, the currency was officially pegged to the dollar at Dh3.67. Despite the weakness of the greenback, it remained the anchor currency for the UAE’s monetary system.
On November 23, 1978, Gulf News reported that the UAE was losing $60 million every month in lost oil revenue because of the instability of the dollar.
The then oil minister Mana Saeed Al Oteiba was quoted as saying that the oil-producing nations should not press for the dollar’s replacement as the pricing medium of oil.
Earlier this month at the Opec meeting in Riyadh, the oil ministers from the Gulf Cooperation Council (GCC) resisted the demand from Iran and Venezuela to discuss the possibility of a new pricing mechanism for oil away from the dollar.
Economists argue that the GCC states, including the UAE, are suffering substantial losses in terms of oil revenues and the value erosion of dollar denominated assets due to the weakness of the dollar.
Why then this unrequited love for the dollar? Historically, the peg served as the stabilising factor when government surpluses were not as high as now. Regional politics also played a role in keeping the peg unchanged.
There have been discussions at the highest level whether the country should change its exchange-rate mechanism because of the dollar’s persistent weakness.
Sultan Bin Nasser Al Suwaidi, the UAE Central Bank Governor, said earlier this month the central bank was under growing social and economic pressure to change the dirham’s peg to the US dollar in favour of a basket of currencies.
The UAE’s inflation rate was more than 15 per cent in 1978. The parallels to the current situation are conspicuous.
The UAE economy is facing inflation of 9.3 per cent, a 19-year high, while one of the key factors behind rising prices continues to be the dollars’ fall in value.
Diversified
The dirham is estimated to have lost 18 per cent and 21 per cent in terms of purchasing power against sterling and the euro respectively during the past two years.
Historically, the main rationale for the peg has been that the economy was heavily dollarised given the high dependence on oil.
Over the years, the UAE economy has been substantially diversified with the hydrocarbon sector now accounting for only about 27 per cent of GDP.
The changing priorities of the economy have necessitated a new thinking on the currency peg and the calls for an independent monetary policy and a flexible currency are becoming ever louder.
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