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Dirham's peg with dollar to stay, says IMF

Mohsin Khan, International Monetary Fund director for the Middle East and Central Asia, told Khaleej Times that a depegging from the dollar — which is "not a step to curb inflation" — is not good for the region's financial stability.

"We believe that it is inevitable that Gulf currencies to stay with the dollar peg until the currency union, which I have no reason to think not possible by 2010," he said. "Gulf states should not alter their currency pegs, which will do little to curb inflation and might threaten perceptions of Gulf currencies as stable," he said as he projected that UAE's GDP would grow 8 per cent to Dh689 billion in 2007 from Dh623 billion in 2006.

Shrugging off the impact of imported inflation on the overall economic scenario of the Gulf oil economies, he said at this point it makes sense to remain with the peg.

When pointed out that the UAE along with other GCC countries faced the effect of imported inflation as the bulk of its imports is coming from non-dollar zones, Khan asked why it was not then reflected in Saudi Arabia and Oman where the rate of inflation is as low as three and 3.4 per cent respectively compared to 10 per cent in the Emirates and 12 per cent in Qatar. "Inflation is not coming from depreciation of the dollar and a consequent higher import cost. Most of it is coming from domestic capacity constraints," he said.

The falling US dollar and rising inflation have prompted speculation that Gulf central banks would revalue their dollar-pegged currencies to protect against the rising costs of some imports. "The gains from revaluation will be very small. The cost you incur is that you lose the perception of currency stability," Khan said.

However, Khan said inflation rates in the GCC — where GDP is expected to grow at a slightly slower pace in 2007 as oil prices and output drop — should ease in 2007 amid a cooling in real-estate prices. “We believe inflation will slow down in both the UAE and Qatar, but any declines will be marginal. We initially expected inflation to drop more, but now we believe it will only drop marginally,” he said.

Inflation in the UAE is expected to fall to 8 per cent this year from 10 per cent in 2006. Price growth in Qatar will fall by 1.8 per cent to 10 per cent over the same period, according to the IMF. “Growth is still very strong in both countries, and it is maintaining inflation rates up but its gradually decreasing,” he said.

Maintaining that increased spending is fuelling inflation, he said inflation for all the Gulf states combined would fall to 4.3 per cent in 2007 as more supply of housing becomes available in the UAE and Qatar, which had the Gulf's highest inflation in 2006, Khan said.

"Inflation should ease as capacity constraints lessen," Khan said. "Most of the spending now is on imports and most of that on foreign labour which doesn't create domestic inflation."

The greenback fell more than six per cent this year versus the euro and other currencies, fanning further inflation fears in the Gulf. The Indian rupee jumped to a near nine-year high to 40 per dollar. The dollar-pegged dirham also eroded six per cent against rupee since the beginning of this year.