U.A.E's Dirham to Gain 5% in 2009 as Dollar Peg Goes, CFC Says

By David Yong and Matthew Brown

July 22 (Bloomberg) -- The United Arab Emirates dirham will appreciate 5 percent in 2009 as faster inflation in the Gulf state forces the central bank to ditch its 30-year peg to the dollar peg next year, according to CFC Seymour Ltd.

The central bank of the U.A.E. will drop the dollar peg by June of next year, linking the dirham to a basket of currencies, including the dollar and the euro, Hong Kong-based currency analyst Carol Chan said in a phone interview yesterday. The dirham will rise to 3.49 to the dollar from its peg rate of 3.6725 today, said Chan.

Inflation in the second-largest Arab economy accelerated to 11.1 percent in 2007 from 9.3 percent in 2006 as rent surged while the weaker dollar and higher global food prices made imports more expensive. With monetary policy tied to the U.S., the U.A.E. has put price caps on basic foods and building materials in an attempt to control prices.

``The people are paying more for a liter of water than oil, and that's damping the people's purchasing power,'' Chan said. ``A change in the currency regime is possible after the second quarter'' because the dirham's weakness added to the higher cost of imports, she said.

The U.A.E. has cut its one-day repurchase rate from 5.25 percent to 2 percent since September, following the reduction of the U.S. federal funds target rate.

U.A.E.'s oil-rich economy expanded 16.5 percent to 698.2 billion dirhams ($190 billion) in 2007, or 1.3 percent of the size of U.S. economy, according to data compiled by Bloomberg.

Monetary Union

Governor Sultan Bin Nasser al-Suwaidi will likely abandon its current fixed-exchange regime because it's limiting the central bank options to temper inflation amid surging prices of wheat, rice and other grains, Chan said.

``There's a high probability'' the U.A.E. will link the dirham to a basket of currencies after Abu Dhabi's Department of Planning and Economy signaled the country should abandon the peg, Chan said.

U.A.E.'s inflation will accelerate to 12 percent in 2008 given that imported food such as rice and wheat have increased at an annual pace of 41 percent, she said in a separate report on July 17.

Kuwaiti Dinar

The Kuwait dinar has appreciated 8.1 percent since the central bank scrapped its five-year dollar peg on May 20, 2007 to help contain inflation. Kuwaiti consumer prices rose an annual 10.1 percent in February, as the stronger currency failed to stem rising rents.

Al-Suwaidi, reappointed as Governor to a fifth term on July 14, last year advocated reviewing the dirham's peg to the dollar, sending the U.A.E. currency to a 20-year high. He announced in January that a review had taken place and said in April the dollar's slump hindered the Gulf nation's fight against inflation.

Traders are betting the dirham will rise to 3.63 per dollar in 12 months, according to non-deliverable forwards contracts. They had expected the exchange rate to reach 3.5573 on March 20.

Gulf central bank governors will meet in September to finalize a draft of the Single Currency Agreement, a framework for monetary union by 2010, before passing it onto finance ministers and eventually to heads of state in December.

The agreement will then need to be ratified by governments including Saudi Arabia, the United Arab Emirates, Qatar, Kuwait and Bahrain. Oman, which makes up the six-state Gulf Cooperation Council, pulled out last year.

To contact the reporter on this story: David Yong in Singapore at dyong@bloomberg.net; Matthew Brown in Dubai at mbrown42@bloomberg.net