Identifier
Created
Classification
Origin
06ABUDHABI4555
2006-12-27 13:31:00
CONFIDENTIAL
Embassy Abu Dhabi
Cable title:  

UAE- MONETARY UNION AND REVALUATION

Tags:  EFIN EINV ECON GCC AE 
pdf how-to read a cable
VZCZCXRO4613
PP RUEHDE RUEHDIR
DE RUEHAD #4555/01 3611331
ZNY CCCCC ZZH
P 271331Z DEC 06
FM AMEMBASSY ABU DHABI
TO RUEHC/SECSTATE WASHDC PRIORITY 7965
INFO RUEHZM/GULF COOPERATION COUNCIL COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHEHNSC/NSC WASHDC
C O N F I D E N T I A L SECTION 01 OF 03 ABU DHABI 004555 

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NSC FOR MCCORMICK
STATE FOR NEA/ARP, EB/IFD/OMA
STATE PLS PASS TO USTR FOR SDONNELLY, DBELL, KCLAYMAN
TREASURY FOR U/S ADAMS, DAS SAEED

E.O. 12958: DECL: 12/27/2016
TAGS: EFIN EINV ECON GCC AE
SUBJECT: UAE- MONETARY UNION AND REVALUATION

REF: A. ABU DHABI 3709

B. ABU DHABI 2913

C. ABU DHABI 1472

Classified By: AMBASSADOR MICHELE SISON FOR REASONS 1.4 (B) AND (D).

C O N F I D E N T I A L SECTION 01 OF 03 ABU DHABI 004555

SIPDIS

SIPDIS

NSC FOR MCCORMICK
STATE FOR NEA/ARP, EB/IFD/OMA
STATE PLS PASS TO USTR FOR SDONNELLY, DBELL, KCLAYMAN
TREASURY FOR U/S ADAMS, DAS SAEED

E.O. 12958: DECL: 12/27/2016
TAGS: EFIN EINV ECON GCC AE
SUBJECT: UAE- MONETARY UNION AND REVALUATION

REF: A. ABU DHABI 3709

B. ABU DHABI 2913

C. ABU DHABI 1472

Classified By: AMBASSADOR MICHELE SISON FOR REASONS 1.4 (B) AND (D).


1. (C) Summary: UAE Central Bank Governor Al-Suwaidi said
that the GCC would need "to talk about" the implications of
Oman's decision not to join the GCC currency union as
currently scheduled. So far, the UAE Central Bank appears to
be resisting any changes to the dirham's peg to the dollar or
revaluation of the currency. Central Bank officials note
that imported inflation is not a major problem. They note
that UAE inflation is largely driven by structural
bottlenecks (such as housing) which are slowly unwinding. A
revaluation, in their view, would not necessarily slow the
growth in liquidity in the UAE and might increase it. In
addition, revaluation would come with costs (to the value of
overseas investments, the competitiveness of non-oil
exporters, to tourism receipts, etc.),which would need to be
considered. Poor trade statistics would limit the
effectiveness of changing the peg to a basket of currencies.
The Central Bank's Economic Advisor did note that other UAE
entities have been putting pressure on the Central Bank
either to revalue or change the peg, and that he has started
to do a more detailed cost benefit analysis on his own
initiative. He stressed, however, that so far the Central
Bank Governor believes that the costs of change outweigh the
benefits. End Summary.


2. (C) The large foreign exchange reserves accumulated by GCC
countries over the last few years, the weakness of the
dollar, and increased inflation in the UAE have heightened
speculation that GCC countries might either change from a
dollar peg or revalue their currencies. UAE's Central Bank
Governor Sultan Nasser Al-Suwaidi has consistently resisted
either revaluing or changing the peg in advance of the GCC's
planned monetary union in 2010. Oman's announced decision

that it would not join the monetary union as currently
scheduled appears to be forcing an evaluation of the currency
union and may move the question of changes to the peg
forward. So far, however, the UAE Central Bank does not
appear to believe that either revaluation or changing the peg
is in the UAE's interest.

Prospects for Currency Union - TBD
--------------


3. (SBU) On the margins of the December 20-21 meeting of the
UAE's national Anti-Money Laundering Committee, Al-Suwaidi
told Econchief that the GCC "would need to discuss" the issue
of the currency union. He has previously been quoted as
saying that he thought the currency union would move forward
but in a more limited fashion.


4. (C) On December 19 Central Bank Economic Advisor Abdalla
Malki told Econchief that most of the technical issues
related to a currency union had already been agreed to. The
decision to proceed was essentially a political one, which
had not played itself out. Malki also said that, although
the criteria for a currency union were generally achievable
(budget deficit, gross debt, inflation),the influx of
liquidity from high oil prices made it more difficult to
achieve the inflation target. Malki went on to say that the
GCC states needed to have a common basis for measuring
economic statistics. He noted that while the UAE was
currently running an inflation rate of about 10%, he
seriously doubted that the Saudi figure of 2% inflation was
accurate. "Are they measuring the same thing?" he asked
rhetorically.

Al-Suwaidi still resistant to changes to peg
--------------


5. (C) Al-Suwaidi has consistently resisted changing the
UAE's peg to the dollar, either by pegging to a basket of
currencies or by revaluing. He has said that he thinks that
a future GCC common currency would eventually float, but has
intimated that the time is not right for the UAE to move to a
flexible exchange rate. Malki explained that the Governor
believed that the costs of revaluing would exceed the
benefits. In addition, he noted, any change would need to be
coordinated at the GCC level. Kuwait had pegged to the
dollar with a small adjustment band, he explained, a
unilateral revaluation was within its rights under the GCC
agreement. Even so, he noted, Kuwait's action had caused

ABU DHABI 00004555 002 OF 003


tension within the GCC. The UAE had a hard peg to the dollar
and did not have the same room to maneuver. Malki confided
that -- on his own initiative -- he was starting to examine
more closely the costs and benefits of revaluation, but
explained that, so far, the Governor was not convinced of the
merits of change.

Dollar Weakness not major cause of inflation
--------------


6. (C) Malki told Econchief that "other entities" in the UAE
had put some pressure on the Central Bank to either revalue
or to break the peg. He commented that they were operating
under the -- mistaken -- assumption that a peg to the
weakening dollar was a major cause of imported inflation.
According to the Central Bank's estimates, 70% of the UAE's
exports are denominated in dollars (90% if re-exports are
excluded). Around 80% of the UAE's imports are either dollar
denominated or in currencies pegged to the dollar. According
to Malki, even the Japanese price their exports to the UAE in
dollars. The 20% not in dollars was represented largely by
Euro-zone exports. Malki stated that the UAE's inflation was
more related to structural inflexibilities in "non-tradables"
such as rents and other local costs that were being driven by
excessive growth. Malki noted that the UAE Minister of Labor
had said that he had issued 500,000 labor permits in 2005.
Even if only half of the permits actually led to new people
coming to the UAE, this represented a 6% increase in the
population of the UAE in one year. Many of these people
would need housing, food, and other services. (Note: some
large percentage of these immigrants would be relatively
unskilled construction laborers, who would be housed in labor
camps and not put pressure on the housing market. End note).
Malki noted that inflationary pressures were expected to
decline in 2007 as more housing units came on the market and
the rate of rent increases dropped. (Note: Both Dubai and
Abu Dhabi have also instituted rent caps, which should slow
the increase in rents. End note.) Malki noted that he
thought that inflation in the UAE was already coming down.
Food prices were dropping back toward those of the beginning
of the year. If inflation drops, he said, he anticipated
that the "political" pressure to revalue would decline.

Lots of Liquidity - Revaluation won't stop it
--------------


7. (C) Malki argued that a credible peg had proven beneficial
by limiting currency risks and reducing hedging costs. The
UAE Central Bank had proven that the peg was credible, by
providing the market with all the dollars demanded. The UAE
was already attracting a great deal of foreign investment
($20 billion in 2006, two-thirds more than in 2005). A more
valuable currency could be more attractive to investors
leading to even greater inflows of capital (and greater
inflationary pressure). Malki acknowledged that the Central
Bank mirrored low U.S. interest rates, which encouraged
growth. He commented, however, that increasing interest
rates would only make investments in the UAE more attractive
and could attract more capital inflows. Malki explained that
the UAE already had high reserve requirements of 14% on many
types of deposits in an effort to control the growth in the
money supply. Increasing these rates would only cause banks
to shift deposits to their foreign branches then borrow the
money from abroad to finance lending in the UAE and avoiding
the reserve requirements. He noted that foreign liabilities
of the commercial banks had already increased by an estimated
70% in 2005 indicating that some banks were already following
this strategy.

Trade weighted peg founders on poor statistics
-------------- -


8. (C) Malki stated that the UAE's statistics were
problematic. Although the central bank had good statistics
on the financial system, statistics on the real economy were
poor. Malki noted that not only were the baskets of goods
used in calculating the Consumer Price Index (CPI) dated,
they were based on a city of Abu Dhabi survey that was not
relevant to other parts of the UAE. These statistical
issues made pegging to a trade weighted basket of currencies
difficult, he explained. He said that he had once
recommended pegging the dirham to a basket of currencies, but
had discovered that the trade statistics were unreliable,
with IMF data differing significantly from the data provided
by the Emirates' customs departments.


ABU DHABI 00004555 003 OF 003


Comment
--------------


9. (C) The weakness of the dollar, higher inflation, and
diminishing prospects for a currency union all appear to be
putting pressure on GCC nations to revalue. In the UAE's
case, however, the Central Bank Governor still appears to
believe that the costs of near-term change outweigh the
benefits. The Central Bank has significant dollar holdings.
Well over 90% of its estimated $28 billion in reserves are in
dollars. ADIA has an even larger value of dollar assets.
Revaluing the dirham would undermine the value of these
holdings. Revaluing the currency could also hurt the UAE's
efforts to diversify its economy away from oil and gas by
making other exporters less competitive and making the UAE a
more expensive destination for European tourists. (Note:
Since many of the UAE's developing new industries from
aluminum to cement to petrochemicals are growing to meet
rapid domestic growth, impact on export competitiveness might
not be that important a consideration. End Note.)


10. (C) The Central Bank is also not likely to accept the
argument that a revaluation in the dirham will help reduce
global savings imbalances or trade imbalances with the U.S.
specifically. According to the latest IMF estimates, the
increase in imports from 2005 to 2006 roughly paralleled the
increase in exports (28% for exports and 24% for imports).
U.S. exports to the UAE have already grown rapidly and the
U.S. has traditionally maintained a trade surplus with the
UAE. U.S. exports to the UAE for the first 10 months of 2006
are already 18% greater than those for all 2005.

11 (C) Although we judge that Governor Al-Suwaidi has
calculated that changing the peg or revaluing the dirham has
more costs than benefits, he is subject to both external and
internal pressures. If the GCC commits to a revaluation, the
UAE will likely follow consensus. At the moment, however, it
does not appear that the UAE will lead a charge toward
change. The UAE's response could change if the dollar
collapses or if the Central Bank's cost benefit calculations
shift. It is instructive that Malki is starting to look more
closely at the details of a revaluation, should the question
be asked.

End Comment.
SISON