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 
 
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