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30pc chance of dirham revaluation seen

Steve Brice, chief Middle East economist at Standard Chartered Bank in Dubai, said while it is very unlikely that dirham would be delinked from dollar, a small revaluation of between three and five per cent could not be ruled out.

"The question is, now that Kuwait abandoned dollar peg, will the UAE follow suit since the Central Bank governor had said that the country would not unilaterally switch its exchange rate mechanism," he said. "However, the central scenario is that the UAE will not change," he told Khaleej Times.

While the UAE Central Bank kept silent on the surprise move, the Kuwaiti dinar yesterday remained steady against the dollar. The Kuwaiti currency strengthened 0.4 per cent on Sunday soon after the decision to dump the peg and link the dinar instead to a basket of major world currencies.

While a UAE revaluation would further impede the prospects of a GCC monetary union by the 2010 deadline, it would also further weaken the dollar. Scandinavian bank Nordea was quoted by Reuters that “if other countries in the region will follow Kuwaiti dinar, we see a risk of a modest dollar weakening.”

“We shall be closely watching the UAE, which should be the next one on the list,” said Elisabeth Gruie, Emerging Markets Strategist at BNP Paribas in London.

While Kuwaiti economist Hajjaj Bukhdour said the dinar's switch to a basket of currenceis will help reduce imported inflation, a Dubai-based analyst said it would derail the monetary union programme and do little to curb inflation.

Kuwait's unilateral move reflected difficulties faced by the GCC to achieve their target by 2010, especially after Oman had announced it will not be able to meet the target date. According to experts, the main stumbling blocks include agreement on inflation rate, which has soared in Qatar and UAE and the lack of political willingness by member states to relinquish part of their independence in favour of a single currency,

Bahrain Economic Society member Mohamed Habib Ali was quoted as saying that Bahrain's policy of pegging its currency to the US dollar is fuelling inflation and damaging investment. "The dinar's fixed relationship with a rapidly devaluing dollar is no longer to its advantage. The policy is neither controlling inflation nor protecting the external value of the dinar very well," Ali was quoted in a local daily. The solution would be the use of a basket of currencies including the euro and others, as well as the dollar, to guide monetary policy across the GCC region.

Explained another economist: "The GCC nations are importing much more than they are exporting. Therefore, if the imports are mainly non-dollars and are in other currencies, it must have a more negative affect. Ten per cent of GCC imports come from the US, but those from Europe and Asia each account for a third. In addition, two-thirds of the GCC's energy gets exported to Asia. Thus, from a trade-weighted perspective, pegging exclusively to the dollar does not make much economic sense and the GCC should definitely diversify much more in its currency reserve basket."

"If the GCC is exporting its major commodity with dollars and only 10pc of its total imports come from the US, using those dollars, a further depreciating dollar will cause an unprecedented rise in prices of imports," he said.