Kuwait revalued the dinar against the US dollar on Thursday by one per cent. It was a major story in international currency markets, as traders speculated that Saudi Arabia and the UAE would follow suit.
Currency revaluation in Kuwait sounds a bit obscure.Why should we care here in Dubai?
First of all, do not panic. This is not going to destabilize the economy. Currency markets are speculating that the UAE will also raise the value of the dirham, which is why a lot of foreign exchange traders and business people here are watching this like a hawk.
But by early yesterday morning, the UAE Central Bank the government organization that makes these decisions had declined to comment.
So we shouldn't care?
In the short term, no. Partly because the UAE hasn't done anything yet. Partly because, even if it did, revaluing the currency by one per cent is not going to have much of an impact for anyone apart from currency speculators.
In the medium term, though, if Gulf countries such as the UAE do start raising their currencies, we are all affected from expatriate doctors working in Dubai to save for their retirement, to major UAE firms importing cars from overseas.
Let's take a step back. What is a currency revaluation?
Gulf currencies are all pegged to the dollar. Here in the UAE, one dollar has cost Dh3.671 for two decades. It does fluctuate around the margins a bit, but not much. The UAE can set this rate because the Central Bank promises to sell you and I as many dollars as we want at this rate.
Kuwait is a more recent convert to currency pegging, matching the dinar to the dollar back in 2003 as a precursor to the Gulf single currency.
On Thursday, Kuwait reduced the price of $1 by one per cent to KD0.29963.
The flip side is that dinars are now more expensive when you are buying in dollars. That is called a currency revaluation.
Why did Kuwait do that?
In simple terms, because a lot of international currency traders wanted to buy dinars to speculate, and that worried the Kuwaiti government.
At six per cent, Kuwaiti interest rates are higher than rates in the United States (five per cent), which encourages currency traders to make what are called "carry trades".
Think about it. If you are a clever currency trader and most are you can borrow money in dollars, paying five per cent interest, and buy dinars, earning six per cent.
That may not sound like much, but if you are talking about billions of dollars, then you can make a tidy profit.
Kuwait, like most small countries, does not want traders in New York, Hong Kong and Dubai playing with its currency, as money flowing in and out can destabilise the economy.To deter carry trades, Kuwait could do two things: either reduce interest rates or make its currency more expensive.
It does not want to reduce interest rates, because it is using higher rates to fight domestic inflation. So it chose the second option to make the dinar more expensive.
Enough about Kuwait. What is happening here in the UAE?
The key thing here is the "what if" scenario. First, what if the UAE does follow suit and revalue by one per cent? And what if one per cent is just the beginning, and we carry on revaluing up to 10 or 20 per cent?
This is not pie in the sky. The Gulf states plan to form a single currency just three-and-a-half years from now, so they are already following similar trends in the way they manage their currencies. And the United States is putting pressure on the Gulf states to revalue, as it thinks weak Gulf currencies are one of the reasons oil prices are so high.
You still have not told me why this matters to ordinary people in the UAE.
For consumers, a stronger dirham would probably be a good thing. A stronger currency would mean cheaper cars, electronic goods and food on the supermarket shelves. Primarily cheaper US goods, but it should also make Japanese televisions and European oranges cheaper.
It would also mean that, for expatriates, we would get more of our home currency when we send our dirhams back to Frankfurt, Mumbai or Sydney.
And for businesses?
Mixed fortunes there would be winners and losers.
The winners would be the big importers. The weak dollardirham in recent years has squeezed their margins they have had to pay more to import Land Cruisers and Roche Bobois sofas, but may have not been able to pass all that extra cost on to you and me.
However, exporters would suffer. That includes the guys manufacturing everything from glass to artificial football pitches at places such as Dubai Investments Park.
Perhaps more important, it would hurt Dubai's hotels. The weak dollar-dirham has made the Royal Mirage relatively cheap for German and British tourists in recent years, and their shopping trips to Mall of the Emirates have also been good value. A stronger dirham would make Dubai more expensive for them. Finally, it would also make the UAE more expensive for foreign investors.
We have also got to look at interest rates.
If the UAE revalued or even floated the dirham, that would allow the Central Bank to raise interest rates higher than the current five per cent.That would be good news for savers, but bad news for people with mortgages, or businesses that have just taken out a big loan to invest in a new factory.With inflation so high in Dubai, higher interest rates would be very tempting for the Central Bank.
What do authorities in the UAE think?
The UAE has enjoyed an extremely stable economy for the past two decades, and has attracted a lot of domestic and foreign investment on the back of that. The Central Bank says the dirham peg is a big part of that. Quite rightly, it says it is not going to start playing with the dirham, surrendering 20 years of stability to address short-term issues.
Also, if it did revalue, the government would get fewer dirhams for each barrel of oil sold.That is not a huge problem the UAE is wealthy. And it is not as if the UAE is crippled with local debt, as opposed to somewhere like Lebanon. But still, it is a consideration.
So what happens next here in the Emirates?
In the short term, probably nothing. As I said, the UAE Central Bank is a big fan of stability and the status quo, so do not expect any knee-jerk reactions. But as we move towards forming a single currency in the Gulf in 2010 which will creep up sooner than we all think some change is all but inevitable. This will impact the value of the dirham in your pocket, and the company you own or work for.
More banks in the UAE are hiring economists to try to make sense of these things. Listen to them. If you know what is coming, you can plan for it. Economics may be the dismal science, but at the risk of repeating myself, it is even more dismal to suddenly find yourself knocked sideways by a massive currency shift that you could have but did not see coming.
Richard Dean
Emirates Today 2006
