Dollar Link Should Be Consigned To The Sands Of Time

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 – 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.

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