Do we need a revaluation?

As the dirham faces further value erosion following the dollar's decline against major international currencies, UAE residents are becoming poorer as the currency buys less and less of what it used to in the past.

In the context of rising domestic inflation and falling exchange rates, economists, exchange houses and currency traders have been calling for a revaluation of the dirham.

Despite prolonged anticipation, the UAE Central Bank has not given any indication that the country will revise or undo the dirham's peg to the dollar. On the contrary, the central bank said last week that the UAE is committed to the peg.

"Our commitment to the dollar peg is a collective decision by all GCC central banks. We are not yet ready to change it," Sultan Nasser Bin Suwaidi, Governor of the UAE Central Bank, told reporters recently in Damascus.

The UAE economy is facing a unique situation due to high growth, high inflation and low interest rates as the dirham faces further erosion as a result of the falling dollar.

Due to the inherent weakness of the US economy and the tightening credit situation in the US, economists expect the dollar to decline further.

Serhan Cevik, an economist at Morgan Stanley, said that the weaker dollar would worsen the already high inflationary pressures in the GCC. "Imported inflation is becoming a bigger threat as currencies pegged to the dollar keep weakening," Cevik said.

Diminishing earnings

With rising inflation and the falling exchange rates, a major share of the earnings of UAE residents is vanishing into thin air.

While the UAE nationals and expatriates alike are feeling the pinch of the rising cost of living, the large expatriate population living and working in the country is facing the risk of losing a significant share of earnings to inflation and currency volatility.

Last year the country's inflation hit a 19-year high of 9.3 per cent. "The Indian rupee has gained more than 14 per cent against the dirham from the beginning of the year. The exchange rate losses combined with domestic inflation is wiping out more than one third of the earnings of Indian expatriates working in the UAE," said Sudhir Shetty, general manager of the UAE Exchange Centre.

Most western expatriates have also suffered heavily from the dirham's fall. The dirham fell 17 per cent against the euro from December 2005 to the end of August 2007 and dropped 16 per cent against sterling.

The sharp decline of the dollar against major currencies has revived the debate about the dirham's revaluation as a viable solution.

"We still believe that the UAE is the country most likely to move next after Kuwait with regard to currency reform. We forecast a 15 per cent probability of the move this year, increasing 40 per cent in 2008," said Monica Malik, an economist with EFG-Hermes.

Faced with the dirham's falling purchasing power and appreciating currencies in their home countries, expatriates are facing huge financial losses. Analysts say that due to limited investment options available to small and middle income expatriates in the UAE, this group is more vulnerable to the decline of the dirham.

Expatriates dip into savings

"Small and middle income groups have relatively larger commitments in their home countries. With the exchange rates of the dirham falling substantially against their home currencies, many are forced to dip into their savings or borrow to send money home," said Shetty.

The impact is heavy on those who have loans to pay and bills to settle in their home countries. European, British and Indian expatriates are facing big losses as their home currencies have gained substantially against the dirham.

"If the GCC governments are serious about containing inflationary pressures and realise that this is largely demand driven, they will have no choice but to carve out some independence in monetary policy," said David Lubin, economist at Citigroup, "However, this means they will first have to abandon their fixed dollar pegs, which is no small task for a region that has maintained these pegs for decades."

In May, Kuwait abandoned the dinar's peg to the dollar in favour of a basket of Gulf currencies. While Lubin believes that Kuwait's decision was the only way forward, he said that in the near term, the GCC countries are unlikely to respond to market pressure by de-pegging their currencies.