Economists, banks, business magazines and investment banks speculated from Dec 2005 until 2008 on the possibility of revaluing the dirham (currency of the UAE). The UAE dirham is pegged to the USD at a fixed rate of 3.6730 since the 1980’s.
My stance for the longest time has been that revaluation is highly unlikely and mostly will not happen.
Banks such as Standard Chartered, EFG Hermes, Morgan Stanley and a leading business magazine-Arabian Business amongst others, all contributed to the speculation and claimed the revaluation is just days away. This despite the fact that H.H. Sheikh Mohammed bin Rashid Al Maktoum, Vice-President and Prime Minister of the UAE and Ruler of Dubai along with the Governor of the Central bank, H.E. Sultan Nasser Al-Suwaidi, came out in favour of the dirham and stated that there was no such measure to be expected. They, however, did form a committee to evaluate the revaluation in April 2008. Regardless, the rumours would not go away. Banks speculated and so did people causing a lot of pressure on the interest rates in Dirham.
Under normal circumstances there would be no major difference between interest rates of UAE dirham or the US dollar in the UAE. However, due to the speculation, the interest rates on UAE dirham kept on declining, forecasting a revaluation of the currency. Residents were keen to convert their USD and other currency holdings into AED in order to benefit from the revaluation (and willing to accept a lower interest rate), should the fixed exchange rate be altered by the Govt. But, alas, it was not to be!
My comparison of revaluation has always been to the social institution of marriage. UAE was having a rough time due to high inflation because of low USD interest rates and high commodity prices and the going was rough. Just like a marriage, if the going goes tough, it does not mean that the solution is to dissolve the marriage or change its terms and conditions. You have to take the good with the bad. In good times, for almost 3 decades, the USD pegged exchange rate helped the UAE, so why should it revalue when the going got bad for a few months or in one year. In any long term strategy, you cannot alter your course due to some short term hiccups.
Additionally, I also believe that revaluation would have caused the sudden increase in the prices of real estate in UAE over night by waiving of a pen. This may have caused sellers and speculators to sell for a quick profit leading to volatility in property prices. Especially if revaluation was made for more than 15%, as many observers were expecting. This would have meant that prices of real estate would have risen by 15% since all real estate is dominated in dirhams.
The volatility in the currency and its interest rates had become so high that at least 2-3 times over a period of 3 years the foreign exchange departments of various banks in UAE had to shut trading between UAE dirham and USD, to ease off pressure on the dirham (over a weekend).
The interest rates and forward swaps also fluctuated. Many clients booked forwards on their dirham currency exposures.
Everyone thought that if the dirham price went up, they would make a profit over night. Estimates of revaluation fluctuated from 2-3% up to 20%. Neither was to happen.
In my opinion, had the revaluation occurred, the maximum would have been 2-3% but most of the market makers and many clients disagreed.
Now, we have the example of various European countries who have not joined Euro and hence their currencies have fallen apart. Best example is Icleand whose currency went downhill. Apparently other countries are happy that they joined the European monetary union and accordingly have not suffered much.
This reconfirms the faith of smaller currencies that if they are pegged or aligned with some of the stronger currencies, they will continue to be safe even if the bad times roll.
Read here:
Published: Dec 6, 2008
theglobeandmail.com
Euro's lustre shines bright in hard times
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