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March 2, 2013  

Policy Objectives of the UAE Central Bank

By Mohammed Almahmoud

October 29, 2012

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The main objective of The Central Bank of the UAE (CBUAE) is to ensure a balanced growth and maintain a fixed exchange rate of the “Dirham”, the UAE local currency, against the U.S. dollar. It is stated in article 5 of Union Law No. (10) of 1980, that the UAE central bank that “Shall direct monetary, credit and banking policy and supervise over its implementation in accordance with the State’s general policy and in such ways as to help support the national economy and stability of the currency.” (1)

The UAE has adapted the fixed exchange rate regime to serves it’s oil-based economy well and supports its counter-cyclical policy. The exchange rate stability serves the UAE specific goals because it stabilizes the government budget and it is the best option for a small open economy. A fixed exchange rate against the dollar stabilizes the government inflows and outflows. If the UAE gives up the fixed exchange rate, the Dirham exchange rate is expected to fluctuate according to the oil price fluctuation. That would harm the UAE ability to plan and control their budget.

The Central Bank of the UAE (CBUAE) operating target of monetary policy is to use a number of instruments to attain its monetary objective which is a fixed peg of the Dirham to the US dollar. “The UAE central bank uses banking policies, credit and monetary policies, to ensure the growth of the national economy of the UAE in a balanced manner and maintain a fixed exchange rate of the Dirham against the U.S. dollar and to ensure the free convertibility of the national currency into foreign currencies.” (2)

The CBUAE uses some instruments to achieve its operation target. One essential instruments is the Dollar/Dirham swaps for Dirham liquidity. The CBUAE “injects Dirham liquidity in case a bank needs access to Dirham. Swap arrangements involve a simultaneous sale and forward purchase of Dollars against the purchase/forward sale of equivalent Dirham amount for a fixed term at specified forward rates.”

Other Qualified Monetary Instruments that the CBUAE uses include:

  1. Minimum Reserve Requirement which is 14% on current, savings and call accounts.
  2. Advances and overdraft facility for banks which provide loans and advances for up to 7 days without collateral, and for up to 6 months against collateral.
  3. Prudential Regulation.
  4. Certificates of Deposits and Repo facilities on Certificates of Deposit (CDs) held.
  5. Liquidity Support Facility.

As for the fiscal policy, it is worth mentioning that the UAE has been named the world’s most efficient country in terms of governmental fiscal policy (4). The report, issued by the International Institute of Management Development in Switzerland (4), cited the UAE’s no-tax regime, efficient social security policy and pension scheme as well as the efficiency of the governmental budget in managing surpluses and spending as key reasons for its excellence over the United Kingdom, Japan, France and China.” (5)

The fiscal policy of the UAE not formally stated. But the Vision of UAE Ministry of Finance gives some insight of the UAE fiscal policy. It is stated that “The ministry is a world class in the managing financial resources for sustainable and balanced development”. But at the recession period, the government adapted an expansionary fiscal policy to stimulate the economy and to support the recovery. According to the concluding statement of the United Arab Emirates 2012 Article IV consultation, “The recovery was supported by an expansionary fiscal policy.” (3)

The UAE government is adapting a no-tax regime with almost no government debt outstanding. That leaves the fiscal policy with one main objective: stabilizing output. Some other goals might include stabilizing prices and keeping unemployment low. In the long run, the UAE tries to support the non-oil sector to decrease the dependency on oil. The UAE uses government uses two main fiscal instruments to stabilize output; direct transfers to citizens and government purchases and investments. The government makes direct transfers to the citizens who consist only 19% of population (6) and some subsidies for basic goods.

Timeline:

2008 July – The UAE cancels the entire debt owed to it by Iraq – a sum of almost $7bn.

2008 Since the late 2008 crisis, “In light of low U.S. interest rates, monetary policy stayed accommodative under the fixed exchange rate regime, which has continued to serve the economy well. Banks remained amply liquid but private sector credit growth did not pick up.” (3)

2009 February – Dubai sold $10 billion in bonds to the UAE in order to ease liquidity problems.

2009 A 21% increase in the government spending.

2009 May – The UAE withdraws from plans for Gulf monetary union (6 oil exporter countries), dealing a blow to further economic integration in the region.

2009 November/December – Government-owned investment arm Dubai World requests a moratorium on debt repayments, prompting fears it might default on billions of dollars of debt held abroad. Abu Dhabi gives Dubai $10bn to help pay debts.

2010 UAE government spending and inflation rate at a low level.

2010 Oil revenues increase and the economy recovers.

Using the AD-IA framework, the adjustment of the annual values of real DGP, the inflation rate, and the unemployment rate since 2008 is as following:

Looking at the GDP data, the GDP decreased in by 5% in 2009 and recovered slowly in 2010 (1%) and then increased by 4% in 2011 and 2012. The mean reason for changes in GDP was changes in oil prices as we can see from the chart (7). In 2009, oil prices were around 40 dollars and the UAE witnessed a 5% decrease in GDP.

Inflation jumped to high level at 2008 and 2009, and then was at desire level around 1% in 2010, 2011, and 2012. High inflation was concurrent with high government spending in 2008 and 2009 to stimulate the economy. Moreover, the United States decreased interest rates on the dollar to stimulate the US economy. Since the UAE Dirham is fixed with the US dollar, the UAE central bank decreased the interest rate on Dirham. That caused an increase in money supply which causes prices to go up.

As for unemployment, it ranged between 4.2 and 4.6 throughout the period. So it can be argued that there is a weak correlation between GDP and employment rates in the UAE. In my view, that’s due to two reasons: first, changes in GDP is mainly caused by changes in oil revenues which is capital intensive “industry”. Second, only 19% of the country’s population is citizens (6) and 81% are foreigners. The citizens are guaranteed to have jobs and foreigners are leave the country when they loss their job as the law require.

Clearly, the UAE GDP is highly dependent on oil revenues. With a fixed exchange rate, fiscal policy is most used and effective policy. The UAE accumulate reserves from oil revenues and use those reserves to stabilize the economy. Unemployment is not a challenge for the country due to economic and demographic factors.

Referance:

  1. “Central Bank of the United Arab Emirates. Central Bank of the United Arab Emirates, 2012. Web. 27 Sep 2012. <http://www.centralbank.ae/en/index.php?option=com_content&view=article&id=68&Itemid=107&gt;.
  2. “Central Bank of the United Arab Emirates. Central Bank of the United Arab Emirates, 2012. Web. 27 Sep 2012.http://www.centralbank.ae/en/index.php
  3. . “UAE 2012 ARTICLE IV CONSULTATION.” Ministry of Finance UAE. N.p., 2012. Web. 27 Sep 2012. <http://www.mof.gov.ae/EN/PUBLICATION/Pages/DataandStatistic.asp&xgt;.
  4. . “Methodology and principles of analysis.” World Competitiveness Center. N.p., 2012. Web. 27 Sep 2012. <http://www.imd.org/research/publications/wcy/upload/methodology.pdf&gt;.
  5. . “UAE has been named the world’s most efficient country in terms of governmental fiscal policy..” United Arab Emirates – Ministry of Finance. N.p., 27-09-2012 . Web. 27 Sep 2012. <http://www.mof.gov.ae/Budget/En/Sitepages/LatestNews.aspx?Id=69&gt;.
  6. . “UAE.” The World Factbook. CIA, 2012. Web. 27 Sep 2012. <https://www.cia.gov/library/publications/the-world-factbook/geos/ae.html&gt;.
  7. “Oil prices 2008 to 2012.” Oil-Price.net n.pag. Web. 2 Oct 2012. .