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Foreign Exchange for Expats in the United Arab Emirates

Submitted: December 2013

The national currency is the Emirati Dirham (AED). The central bank of the UAE is responsible for monetary policy.

Exchange rate regime

The Emirati Dirham is dollar is pegged to the US dollar, just like some other Middle East currencies, such as the Saudi Riyal. There is still no monetary union between Gulf Cooperation Council (GCC) countries, but there are plans to introduce one.

Monetary policy

As the central bank targets a specific exchange rate versus the US dollar, there is no inflation target. In theory, this may expose the UAE to the following risks:

  • volatile inflation rates
  • pro-cyclical monetary policies, such as keeping high interest rates when the economy needs stimulus (which further hampers growth)
  • “hot money” flows, i.e. international funds that may try to take advantage of some situations, such as:
    • interest rate differentials between the US and the UAE (they are more or less similar)
    • speculative attack on the fixed exchange rate.

If you wish to know where the UAE monetary policy is going to, you had better monitor the developments regarding US monetary policy, in particular the Fed’s policy. As of 2014, the Fed is gradually “tapering” its monetary stimulus, but without raising interest rates. Whether this will have any tightening effect on UAE monetary policy over the short term is very unclear. Actually, it should not be taken for granted at all. However, any substantial, durable US monetary tightening (involving rate hikes), should force the UAE central bank to follow.

Though monetary tightening tends to drive down asset prices, there is a case to say that the market is still bullish as the global economy recovers from the 2008 downturn. It’s hard to determine how bullish the market is though, as psychological factors tend to play a key part here.

US monetary policy: overview

Since the 2008 financial crisis, the Fed has held interest rates at record lows (between 0 and 0.25%). In addition, it has embarked on an unprecedented series of Quantitative Easing (QE) programmes, whereby the Fed intervenes on the open market to purchase mortgage-backed securities and Government debt. This is basically money printing to avoid deflation and depression.

At the moment, the Fed adds $75bn per month to its balance sheet, down from a pace of $85bn per month in 2013. However, the market largely anticipates the Fed to gradually reduce the pace of its balance sheet expansions throughout 2014. Then comes the issue of downsizing the balance sheet itself and interest rate hikes, and this is not expected to happen anytime soon.

 

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