Why revaluation should be top of the UAE agenda to beat inflation

Revaluation of the dirham should be top of the local economic policy agenda, as the US dollar looks likely to weaken further over the coming few years which will only add more fire to local inflationary pressure.

Step back a moment, and remember that the value of the UAE dirham is fixed to the US dollar by a peg. Hence if the US authorities go for devaluation then that means that the UAE dirham automatically goes down in value by the same amount.

Now the US economy is tipping into a recession or something close to it - driven by a housing slump - while the UAE economy is booming. Therefore the appropriate monetary policy for the US is to lower interest rates and devalue the dollar, which is completely wrong for the UAE as lower interest rates will overheat the local economy causing even higher rates of inflation.

Act today

Given that we can see this scenario quite clearly on the horizon the time to act and begin the process of revaluing the dirham is now, and to wait any longer will mean much higher inflation. Lest we forget high inflation is bad for people on fixed salaries, makes business cost planning tough and hits profit margins, and usually ends in a nasty economic collapse.

However, what we could see in the coming months is a short dollar rally. But only because the US stock market wakes up and realizes how bad the outlook is and has a crash. Then bonds would rally and take the dollar higher for a while until the Fed lowered interest rates and devalued the dollar again.

One rule when you can see a vicious downward spiral opening up in global economics is to try to move your own economy out of the way. The UAE actually has the financial reserves to do this very effectively.

Revaluing the dirham would also revalue local assets in dollar terms and increase nominal GDP. It would allow the UAE Central Bank to set interest rates more appropriate to the development of the UAE rather than the US economy.

Lower inflation

And a revalued dirham would be worth more when buying goods and services from Europe - the main source of UAE imports - and therefore keep local inflation down.

Now at the same time the UAE would earn less dirhams from its oil sales which are priced in US dollars. But that is the whole problem. At the moment the booming oil sector is endangering the health of the diversified UAE economy and beginning to monopolise resources.

The need is for a more balanced approach to economic development, and that can only be achieved if the authorities take back the lever of monetary policy from the US and end the peg to the dollar.

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No option for Fed except a bail out