Has the UAE Outgrown its Pegging to the USD?

The UAE’s Dirham is one of around 60 currencies that use a US dollar pegging. For many years, pegging a currency to the USD was a way to increase confidence and bring stability to the price of imports and exports. This was common among emerging, volatile countries.

It’s clear how the UAE’s decision to peg the Dirham came about — a rapidly growing country entering the global market can more easily engage with large oil contracts (which are denominated in USD) and futures purchases. While many people will wonder what are CFDs, such oil derivative markets are steadier without factoring in currency fluctuations.

But, does the UAE still fit this profile of an emerging global player, and has it been a hindrance to the central bank in this inflationary environment?

Concerns over a lack of control 

When Dirham first became pegged to the USD in 1997, the rate was 3.6725 AED per dollar. To this day, the rate remains the same, despite a widely different situation in relation to the US. The central bank has managed this by storing a large reserve of USD and Dirham, ensuring it can always buy and sell the Dirham to continuously maintain the ratio. Some may compare this to stablecoins, but a central bank poses more power and influence over its own fiat currency.

The pressure to maintain the precise ratio can be difficult during an oil crash. During 2020’s crisis, the Gulf Cooperation Council (GCC) countries felt the strain from reduced dollar inflows. Saudi Arabia’s reserves saw record drops, while Oman’s fiscal deficit ballooned when maintaining these pegs. This caused many investors to bet against these currencies, predicting the pegs would collapse.

If the currency was decoupled, central banks would have had greater control over devaluing their own currency to boost oil exports. The same was said during the inflationary environments over the past few years, which has forced the CBUAE to follow the Federal Reserve in its interest rate policy — policies that were determined with the US economy in mind, not the UAE.

However, there is a reason that gulf nations did not give in to pressures, and it’s not just oil. Dubai, for example, has successfully diversified, reducing oil’s share of its GDP output from 50% to under 1%. The USD denominates so many markets and currencies that central banks around the world, such as the Bank of England, follow closely in the Fed’s policy making footsteps.

BRICS and de-dollarisation

In 2023, the UAE and Saudi Arabia were invited to a BRICS summit in South Africa, which fuelled fresh de-dollarisation debates. The BRICS collective output of crude oil would make up 42% of global output should UAE, Saudi, and Iran join. This has posed the question of whether the USD is needed for oil markets, potentially opening the door to an oil market denominated in the Chinese Yuan or Indian rupee oil.

While the BRICS haven’t been shy about intentions to de-dollarize, we are still far away from a world where it happens. For gulf nations, they are not looking to worsen relations with the West. However, this doesn’t have to be a binary shift, as many are speculating a slow rise in non-dollar-denominated oil trades. Saudi Arabia’s Aramco, for example, is expanding its presence in China. Should this trend continue, we may see the UAE in a position where it’s less dependent on a USD pegging, giving it a clearer choice over its monetary future.

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