Revaluation is the next logical step to tackling UAE inflation

Surely it is only logical then that the next issue for the UAE government to decide upon is whether to revalue the currency against the US dollar to limit imported inflation.

The recent UAE Central Bank report made an important point: the fact that the nation earns its income from oil in US dollars has to be balanced against the fact that the majority of imports are not priced in dollars.

Therefore, as the US dollar has weakened so has the purchasing power of the dirham and the Emirates has had to pay more for its imports, and that amount is passed on to local consumers in higher prices or in other words inflation.

Revaluation option

However, while the UAE remains firmly committed to maintaining the dollar peg, at least until the GCC single currency in 2010, the option to revalue the existing rate of 3.67 to the US dollar is still available; and it could be done by a large enough amount, say 10-15 per cent, to make a major difference to local inflation.

With inflation running at current levels the 16.5 per cent increase in nominal GDP for 2007, announced by the Ministry of Economy this week, was very much lower in real terms and possibly negative.

At the highest levels the debate probably comes down to a clear split between those whose primary interest is the long-term development of the diversified non-oil economy of the UAE, and those who look after the country's huge overseas dollar investments.

The first camp can see immediately that high inflation is damaging the competitive position of the UAE non-oil sector. For example, skilled salaries for Indians rose by 15 per cent in India last year and the rupee revalued by 15 per cent against the US dollar. So in order to compete with India for skilled labour the UAE needs to pay 30 per cent more this year.

Status quo

However, the second camp - the guardians of the accumulated oil wealth - fear that revaluation will damage the value of largely dollar-denominated foreign investments. In nominal dirham terms that would be true, but only at the cost of further distorting the economy towards being even more of a producer of hydrocarbons and an overseas investor.

Hence it comes down to a battle between economic interests within the country, and whether you are more concerned about the damage inflation will cause to the competitive position of an already overheating economy (inflation close to or exceeding nominal growth) or maintaining the value of foreign investments.

It is very seldom that such a matter of national economic policy can be drawn up in this kind of black-and-white position. And all eyes will be on the UAE federal cabinet meeting later this month to see whether policy makers support the argument for change or the status quo.

But the national leaders should be under no illusion about what is at stake. Deciding to do nothing is as big a decision as opting for change, and if tacking inflation is truly the new national priority then the logic favouring change and revaluation is inescapable.