NEW YORK: A move by the United Arab Emirates to drop its peg to the dollar would probably increase downward pressure on the greenback and may push other Middle East states to let their currencies float more freely as well.
But money managers and FX strategists said such a move makes economic sense and does not necessarily spell the end of the dollar’s long reign as the world’s reserve currency.
UAE central bank governor Sultan Nasser al-Suweidi said on Thursday the oil-rich state is facing stiff economic and social pressure to unshackle the dirham from the declining dollar to combat rising inflation.
The dollar’s steady slide this year – it has hit a record low against the euro and a 26-year trough against sterling – has pushed up costs in booming Middle East economies.
And with the Federal Reserve cutting interest rates, Middle East central banks need to cut as well to maintain the pegs even though their economies require higher, not lower rates.
Kuwait was the first to ditch its dollar peg back in May, letting the dinar shadow a basket of currencies instead.
If the UAE follows suit, analysts said it could spark a chain reaction in other Gulf Coast countries with dollar pegs that are facing the same inflationary pressures.
“The question is whether the other countries will also shift, and I have to say the money has to be on a similar shift,” said Divyang Shah, a strategist at Commonwealth Bank in London.
Indeed, other Gulf countries are under similar pressure, with the Saudi king’s advisers calling for a national wage hike and Oman imposing caps on rent increases.
“It’s not a surprising development,” said Paresh Upadhyaya, who helps manage a $30bn portfolio for Putnam Investments in Boston. “The longer term goal in the region was that at some point they would all move away from the dollar peg and move to a basket regime.”
The dollar did not tumble on the comments by UAE’s central banker, though investors said that was largely because markets had long expected price pressures to force the Gulf Coast countries to abandon their dollar pegs.
Some worry that a broader shift away from the dollar peg could reduce demand for US assets in a region with $1tn in surplus funds on hand.
“This is certainly not good news for the dollar, as we’re in an environment where the market is looking for any reason to sell it,” said David Powell, senior currency strategist at IDEAglobal in New York.
When a Chinese official suggested last week that Beijing should favor stronger over weaker currencies, traders pushed the euro above $1.47, its highest level since inception in 1999.
But days later, more senior Chinese officials refuted those remarks, saying the dollar would remain the main component of China’s $1.4tn in foreign exchange reserves.
Analysts noted that even if the UAE did shift to a basket, the dollar would likely remain a large component. Commonwealth Bank’s Shah said a broader shift in the region would help sort out global imbalances caused by inflexible exchange rates in an orderly fashion.
“The UAE is not China. It’s not the end of the world and we shouldn’t exaggerate the significance of this story,” Powell said. China, the world’s second largest holder of US Treasury debt, pegs its currency to a dollar-heavy basket. – Reuters |
