UNPEGGING THE U.S. DOLLAR -  ANCHOR OR MILLSTONE? 

10.12.2003

The U.S. Dollar's sharp decline in the last  few months, has understandably caused much heartburn among the trading and commercial community in Dubai, who bear the brunt of its adverse impact; especially when they are importing goods from countries or counterparties where the invoices are denominated in the Euro, Japanese or Pound Sterling. The landed costs become higher than before and often, such increased costs are difficult to pass on to their ultimate customers. This is not just in the imports of  automobiles, textiles or building materials but quite clearly across the board; given that over 60% of Dubai's imports are denominated in currencies other than the U.S. Dollar.

Of course, one could argue that when the going is good (i.e. when the U.S. Dollar is on the rise, as it was for many periods), these importers had a good profit ride and therefore, all this is really a cyclical burden that they have to be nimble enough to bear and grin and try to pass on to their suppliers or customers. But in high volume and low margin wholesale trading activities, it is difficult to always "charge what the traffic bears" - when the latter have a choice of trading partners in a free trading entrepot, such as Dubai. Similarly, there is also an overall economic impact on the country as well, because its foreign exchange reserves are also held substantially in U.S. Dollars. Effectively, this translates into lower value in terms of the potential purchasing power, even if this is more of an opportunity cost than real. To an extent, higher import costs also result in higher inflation. True inflation has been benign in the GCC region and therefore, the shoe is not pinching as yet!

It is in these circumstances, that some eminent economists may argue that given the proposed GCC monetary union, the countries in the region should consider de-linking their individual currencies from a peg to the U.S. Dollar. Of course, there is no real pressure building up to do this. In geo-political and geo-economic issues of this nature, the GCC will carefully co-ordinate their stance. Furthermore, some say, "you might want to let the sleeping dogs lie i.e. not create a problem or a debate, when there is none!".

Clearly, the U.S. Dollar peg has stood in good stead for the UAE Dirham and for some other regional currencies. Visibly, one does not see the currency volatility and seemingly there is little or no market impact, even if these get absorbed indirectly in terms of the cost of goods and services. An anchor of this nature, has truly a great value in itself; and lends itself to predictable and stable monetary policies.

Besides, on a trade-weighted basis, the U.S. Dollar is still a predominant currency in this region. On the export front, much of the oil and other petroleum exports and trading are denominated in U.S. Dollars, as indeed a huge amount of re-exports of other goods and services. Thus the GCC countries are largely insulated against currency volatility.  Currency in stability can inject a high level of uncertainty, that, in turn, can cloud investment decisions. Only the real savvy will feel comfortable, to be able to deal with it, on a constantly changing basis, quite apart from the traders and those of this ilk in the commercial arena!  Others know that the fixed peg against the U.S. Dollar is supported by some very strong financial and interventionist muscle and to that extent, will not want to trifle with the currency i.e. by speculating against it, as was sometimes the case with the Saudi Riyal;  but even there, snuffed out as quickly as it surfaced.

A more important question therefore, may be whether oil exports should continue to be denominated in U.S. Dollars. This might well be something that OPEC or OEAPC can consider as the pros and cons but is a matter that is best decided by a dialogue between the importers of oil and the exporters. Admitted some of the intermediaries will want to have a say; the counterparties  being the so called "seven sisters" of petroleum. Perhaps there are only four now. Like the big 5 accounting firms, the oil majors have shrunk to a smaller number; although a majority of them continue to be of U.S. origin -  excepting for BurmaShell and British Petroleum. There is little likelihood of this (oil) commodity pricing moving to being in a currency other than the U.S. Dollar for the present. However, similar to what Kuwait did, there could well be a case for a basket of convertible currencies to which, the GCC can 'peg'; adjusted within a narrow band to allow for some gradual strengthening or weakening of the domestic currency. A trade-weighted index would suggest the Euro and the Japanese Yen and perhaps Pound Sterling, in addition to the U.S. Dollar.

All such possibilities need to be carefully analysed and the justifications made fairly transparent, so that people can anticipate the likely movements and hedge against them; whenever appropriate. Any such move to a 'basket peg' will give a huge stimulus to the foreign exchange trading community in this region, who are otherwise bereft of "much action" and content to rest on the laurels of the 'crosses' i.e. between the U.S. Dollar, Cable (U.K. Pound Sterling), Japanese Yen and the Euro and even these precious little in volume terms - given that smaller traders tend to accumulate and aggregate positions and the big ones tend to spread their businesses around, with several banks competing for these off-balance sheet ancillaries.  Therefore, it would be unwise to describe the U.S. Dollar as a 'millstone around the neck'. It is indeed a 'sheet anchor'; in the sense of providing rock bottom stability.

Hong Kong's experience in this regard, is instructive. Even after it assumed sovereignty, China allowed this Special Administrative Region (SAR) to retain its linkages with the U.S.Dollar, more as a buffer. Hong Kong, similar to Dubai, has huge trading flows,  is an entrepot and is the capital market for China and indeed East Asia. It is like the goose that lays the golden eggs and the People's Republic of China (PRC) is loathe to disturbing that profitable equation; even on occasions when the peg came under severe stress and nearly abandoned; as in the aftermath of the Asean Crisis. China tends to persist with "two systems and one country policy" on the one (political) hand and yet running two currencies by two different monetary authorities! China's unified policies of decision-making and its huge economy dwarfs Hong Kong's but the latter is as vibrant as the former is stodgy. 

Of course, fixed exchange rates have been abandoned in many parts of the world and the floating rate regime is now in vogue. But usually economic malaise (either  persistent current account deficits or capital flights or fiscal deficits, causing a run on the currency) have caused the 'fixed to floating' migration; none of which, mercifully, afflicts the GCC economies. Apart from the UAE, the fiscal situation of some other GCC states could deteriorate, if the oil prices were to soften but not drastically or dramatically as yet. 

It is this overall monetary and fiscal policy regime that needs to be watched constantly.  Ultimately, nations and regional blocs such as the GCC will have to act in their own enlightened self-interests. Markets do crave for and welcome stability, predictability and policy transparency, and all debates or discussions should be focused on the issues at stake; and devoid of emotional overtones and certainly without any malice, rancour or acrimony. 

Sometimes, for currency anchors, there is a price to pay – mainly during times when the currency is tied to a weaker currency that gets eroded in the market place. But when the peg is to a robust currency with momentary correction, is the choice of most central banks of the world, is the currency of the world's largest economy and as yet, the dominant one, then any debate on chopping or changing is perhaps premature and would have to be dealt with, not at the currency level but on the basis of overall trade-weighted export pricing and other geo-political considerations.

The author is General Manager of Emirates Bank.  However, the views expressed in this article are not necessarily shared by the Bank.

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