Dilemmas of the declining dirham

No-one can say they weren't warned. The UAE dirham is linked to the US dollar (and has been since 1980), and the dollar has been pointing south for a long time. So the dirham could obviously be expected to tumble as well.

The consensus on the dollar has been that it must decline (quite significantly) under the weight of the US trade deficit, but the Gulf region's central banks have indicated many times that the peg with the dollar will remain in place at least until 2010, when the proposed GCC monetary union is due.

Therefore, firstly, the fact that the dollar has broken through 1.30 to the euro and is approaching 2.00 to the pound sterling can come as no real surprise, even if consensus expectation does not have the greatest track record.

That there are now only twelve Indian rupees to the dirham and well over Dh7 to the pound is, secondly, a logical consequence, or rather mathematical certainty while the Dh3.67 to the dollar equation is fixed and the dollar is down.

What does it matter?

For nationals and those long-term resident in the UAE, maybe not so much in day-to-day terms. Foreign products may become more expensive on the supermarket shelves, and in other outlets, because import costs rise, but economists here tend to say this inflationary effect is actually not so strong, for various reasons.

Yet, for those expats paid in dirhams in the UAE, perhaps with shorter-term horizons, and who hope to save some part of income, it clearly also means a loss of real earnings in their home (and other international) currencies. With inflation, especially in rental accommodation, having already impacted pay packets, that's what's known as a double-whammy.

Challenges

There is already some suggestion that, despite its evident attractions as a tourist destination and a place to do business, Dubai in particular is now facing challenges in cost competitiveness and infrastructure bottlenecks. As another thing to consider, from a staffing viewpoint, a weak currency does not help attract the international workforce on which much of economic growth is predicated.

Americans here, and those from countries whose exchange rates are either formally linked or informally related to the dollar (such as Egypt) will not notice the difference so much. However, they are in a minority among expats. India actually has a loose association with the dollar too, through managed floating of the rupee against a basket, but the fluctuation is still significant enough for the effect to be felt. Anecdote tends to suggest that the expat majority generally has noticed the dirham's slide over the past year, particularly the last few months (see charts).

Of course, there is the other side of the coin. The same weak currency is cheaper for businesses based abroad, and operating in other denominations, which are considering whether to come here. Foreigners overseas now, and expats here with income and savings in foreign currencies, can see buying opportunities in dirhams, whether of smaller retail items or bigger ventures such as property. Travel and hospitality, a critical ingredient of the UAE's economic plan, can get a boost.

Decisions on real estate still involve other questions to answer, naturally. Like what freehold entitlement means, what are the other legalities, and whether it is the right time to purchase purely from the demand and supply perspective. That's even without the issue of how much further the dollar may have to go. If it's going to carry on down, the asset you might have in mind is priced in a depreciating currency, affecting not only timing but the decision itself, if it's just a matter of speculation rather than establishing a home.

But that's getting away from the point, which is that this increasingly prosperous country and region - successfully diversifying upon the foundation of relatively expensive oil - are artificially tied to a deteriorating product, namely the paper rolling off the printing presses of the US Treasury.

There are good reasons why the UAE and the other GCC authorities have been inclined to keep it that way, in respect of planning stability, and the pricing of energy exports. Those issues have been much discussed, and probably will be again.

It's ironic, however, that, with stability a cornerstone of policy, that the UAE should be bound to experience such comparative instability in its international exchange rates apart from the dollar.

Even if the gravity-afflicted greenback stages an extraordinary rebound, that itself would not help the stability argument. In fact, quite the contrary. Meanwhile, real value is very much a moving target in dollar terms, as the OPEC countries, for instance, try to gauge their preferred price for oil sales.

Expats in the UAE, and others elsewhere looking at both the positives and negatives of the declining dirham, may wonder just what dollar level might prompt a reappraisal of the GCC states' dilemma.