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POLICY CHANGE UNLIKELY

UAE may create body to monitor FX peg

ABU DHABI, November 27, 2014

By Stanley Carvalho and Martin Dokoupil

An advisory body to the UAE government has suggested that the central bank review the country's currency peg to the US dollar, but local bankers said any change to the peg remained very unlikely for the foreseeable future.

An economic committee of the Federal National Council recommended that the central bank establish a department to oversee the peg, Ali Eissa Al Nuaimi, the committee's rapporteur, told Reuters on Thursday.

The department would review the peg periodically and provide information to the central bank's board to help it make decisions, he added. Since 1997, the UAE dirham has been fixed at a rate of 3.6725 to $1.

"We suggested a study on the dirham-dollar peg, whether it is worthwhile to continue with the peg or delink it, or to think of any other alternative if that is better."

Al-Nuaimi said the government would discuss the recommendation in detail early next year, but stressed that the committee was not pushing for the peg to be abolished - merely for its benefits to be examined regularly - and that there was no link to this year's plunge of global oil prices.

"Oil prices are cyclical and constantly go up and down, and it has nothing to do with our recommendation."

For over a decade, fluctuations in global oil prices and economies have prompted some economists to suggest the UAE consider abolishing the peg and tying its currency to something else, perhaps a basket featuring the price of oil.

This could give the UAE more flexibility to conduct its own monetary policy and manage inflation. A few years ago, when the US dollar was falling, some economists argued that the peg was making the dirham excessively weak.

In the wake of this month's drop of Brent crude oil below $80 a barrel, from around $115 as recently as June, some analysts think the dirham may be becoming too strong, since the UAE relies on oil for the vast bulk of its exports.

"There are people raising the issue of the peg as pressure is building up because of lower oil prices and higher dollar," said Sebastien Barbe, head of emerging markets strategy at Credit Agricole in Europe.

So far, however, there has been no sign that UAE authorities will seriously consider changing the peg, and financial markets are not betting on any change.

The dirham eased to its lowest level against the dollar in over a year in the forwards market on Thursday; one-year dollar/dirham forwards edged up 10 points to plus 4 points, implying marginal dirham depreciation from the peg in 12 months.

However, forwards remain far below peaks of around 500 points hit during the global financial crisis in 2008, when pressure on the Gulf's currency pegs was much heavier. UAE credit default swaps did not move significantly on Thursday.

Local bankers said the government was very unlikely to change an arrangement that had served it well over the years, maintaining stability and investor confidence during political and economic shocks in the region.

"There is no way they are going to change the peg right now. It could drastically reduce the borrowing capacity of the state entities, and foreign investors would be very wary of the exchange rate risk," said a senior trader at a major bank.

He and others saw no compelling financial pressure for any shift. Rough calculations by Reuters suggest that if oil had averaged $80 a barrel last year, the UAE would have posted a current account surplus of about 154 billion dirhams ($42 billion) instead of 238 billion dirhams - still a very comfortable external surplus.

Abu Dhabi's largest sovereign wealth fund is estimated to have nearly $800 billion in assets, giving the UAE plenty of firepower to see off any attack on the currency peg.

Most of the UAE's oil income is denominated in dollars, making it convenient to tie the local currency to the dollar. A new arrangement would immediately add a source of currency risk.

Another issue, bankers said, is that the UAE central bank does not have the experience of managing a dirty float in modern financial conditions. So the process of changing the dollar peg would be risky - risk that authorities are unlikely to embrace.

The central bank did not immediately respond to a request for comment on Thursday. - Reuters




Tags: UAE | Dollar | peg | Dirham |

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