Money Matters

A perpetual topic of discussion, money seems to be weighing more and more on peoples’ minds lately. Is the pegging of many Middle Eastern currencies to the dollar going to signal doom?

These days, in such fiscally turbulent times, the topic on everyone’s mind seems to be money. With the recent US$700 billion government bailout in the United States, many in the GCC have turned their attention towards the region’s monetary policies.

As the UAE dirham remains pegged to the dollar, many are concerned the repercussions of such American actions will inevitably reach the shores of Abu Dhabi and the UAE Central Bank. Though the UAE maintains sovereignty over its own monetary system, the Central Bank has had to answer many questions as of late. Most notably, what are we doing to reinforce stability in the money markets?

Consider that inflation has been hitting record or near-record peaks across the world’s biggest oil-exporting region, where most states peg their currencies to the ailing US dollar, driving up import costs. Dollar pegs have forced Gulf states to track US interest rate cuts even though their economies are booming on a more than six fold increase in oil prices in as many years.

Consequently, money supply in the UAE has maintained “rapid growth” over the past 24 months, despite Central Bank measures to curb its increase by borrowing from local banks and investing the funds abroad. Bankers attribute such rapid growth to a sharp rise in private capital inflow, a fiscal boom in the country and higher public spending on development and other projects. The surge in money supply, which is normally associated with inflation, occurred despite the Central Bank’s measures to stem liquidity growth by sharply boosting the issue of certificates of deposits (CDs), as well as investing the borrowed funds in banks abroad.

According to published reports, the Central Bank borrowed more than AED170 billion (almost US$46.3 billion) from the country’s 24 national banks and 28 foreign lenders in 2007. The borrowing, mostly through CDs, has boosted the combined deposits of those banks with the Central Bank to a record AED231 billion (almost US$63 billion) at the end of 2007 from AED58.4 billion (almost US$16 billion) at the end of 2006. Such a drastic influx of capital has been accompanied by only further escalations in deposits throughout 2008.

As a result, the surge in UAE banks’ combined assets to a record AED1.42 trillion (almost US$387 trillion) at the end of June 2008, has catapulted the UAE to the position of the largest Arab banking sector by overtaking Saudi Arabia. The UAE also ranked first in terms of capital and deposits. The inflow of such investments boosted the Central Bank’s net profits by 42 per cent to AED3.778 billion (more than US$1 billion) in 2007 from nearly AED2.654 billion (more than US$722 million) in 2006. However, those measures have had no impact on domestic liquidity, as curbing money supply growth remains the only fiscal tool available to the Central Bank to tackle inflation.

Confronting the record-high inflation, Central Bank governors from the six-member GCC have been laying out a road map to establish a common monetary institution before 2010. GCC central bankers have agreed to create the nucleus of a joint central bank next year in a major step forward for monetary union but signalled that a new common currency would not be in circulation by the 2010 date.

This September, finance ministers of the GCC met in Jeddah and approved the proposals to establish a monetary council and a draft charter for a monetary union, bringing the six member group, including Saudi Arabia, Qatar, Bahrain, Oman, Kuwait and the UAE, a step closer to launching their single currency.

“The endorsement of the proposals constitutes a major step toward adopting a long-sought single currency,” said Abdul Rahman Al-Attiyah, GCC Secretary-General.

Youssef Kamal, Qatari Finance Minister, who chaired the meeting, confirmed the agreement, “We have asked the central bank governors to complete the requirements for the single currency in future meetings,” he said.

The Qatari minister also downplayed the effect of the region’s currency pegs to the US dollar in increasing inflation in the member countries. He hoped that the improvement in dollar’s exchange rate and fall in shipping costs would bring down inflation.

Perhaps most importantly, GCC central bank governors said last month they saw little systematic risk from the US financial crisis as their exposure to troubled US banks and subprime assets was limited.

“As far as the Gulf region is concerned and especially GCC countries, they are very far from these turbulences that are affecting global markets. Because they don’t have any connection with what has happened,” Kamal said, adding that the GCC economies remain strong despite the recent global developments.

But Dominique Strauss-Kahn, IMF Director General, who attended the Jeddah meeting, said the brunt of the financial crisis may still lie ahead and could weigh on the world economy. However, the financial crisis remains as just one of many obstacles that must be dealt with during the progressive steps to a uniform currency.

“Overcoming the current inflationary pressures, developing a clear vision of the powers of the future common central bank, choosing an exchange regime of the common currency and harmonising financial regulation will be critical to this process,” says the IMF chief.

The ministers are scheduled to meet again on October 26 in Muscat to continue negotiations as well as discuss the location of the monetary council. “Achieving a monetary union will be a major challenge as much remains to be done to enable the creation of a common currency,” says Strauss-Kahn.