The United Arab Emirates, as in the other states of the Gulf Cooperating Council (GCC), engage in an open and free economic system; thereby, encouraging businesses from all over the world to invest in its emirates, particularly in Abu Dhabi and Dubai. To successfully and efficiently conduct trade with their world partners, the UAE employs a monetary system, or a medium of exchange.
There are several definitions for what a monetary system is. Defined according to context a monetary system is "anything that is generally accepted as a standard of value and a measure of wealth in a particular country or region." Financial Times Lexicon defines a monetary system as "the system of money in a particular country or the world as a whole, and the way that it is controlled by governments and central banks." On the other hand, BusinessDictionary.com labels a monetary system as a "set of mechanisms by which a government provides money (cash) in a country's economy." This set of mechanisms is not limited to a mint but also encompasses a central bank which in turn regulates local and foreign commercial banks.
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The Central Bank of the UAE (CBU) operates most of the mechanisms and procedures of the UAE monetary system. CBU was created per Union Law No. 2 of 1973 on May 19, 1973, then known as the UAE Currency Board, and was tasked to replace with a national currency the Bahraini dinar and Qatari/Dubai riyal, which were still circulated after the Union of Emirates was established in 1971. Thereafter, the 260 million UAE dirhams was circulated replacing a total of 12.9 million dinars and 131 million riyals. The rate for the exchange is one dirham for one riyal and 10 dirhams per 1 dinar.
Although, the function of the Currency Board is limited to issuing the dirham and making sure that it is fully covered in both gold and foreign currencies, it guaranteed both the organization of UAE banking and set up rules governing sound banking business with the aid of the International Monetary Fund (IMF).
In December 10, 1980, the Currency Board issued the Union Law No. 10 of 1980, which officially changed it to the Central Bank of the UAE. The said law drafts the functions of the Central Bank, its monetary system, and its organization of banking in order to support the country's fast growing economy.
The passage of 1980 Union Law No. 10, which authorized the CBU to systematize, supervise and implement its monetary, credit and banking policies, supported its financial and economic stability. The law authorizes the CBU to:
Issue currency per provisions of the law;
Ensure support for currency and its stability inside and outside the country as well as its free convertibility into foreign currencies;
Ensure a credit policy which helps in achieving balanced growth of national economy;
Organize and develop banking as well as monitor the efficiency of the banking system, per the provisions of the law;
Functions as the Bank of the Government;
Offer monetary and financial advice to the Government;
Maintain government reserves in gold and other currencies;
Act as bank of banks operating in the country;
Act as financial agent of government at IMF and WB as well as other institutions, and Arab/International Monetary Funds, and handle all State transactions with such parties.
In the homepage of the Central Bank of the UAE, Gov. Sultan Bin Nasser Al Suwaidi, reaffirms the bank's role in maintaining a fixed exchange rate of the dirham against the US dollar and ensuring that the dirham could be converted to other foreign currencies.
Since the time Union Law No. 10 of 1980 was passed, the CBU Board has been implementing, issuing circulars, regulations and decisions, which greatly aided the economic growth of UAE and making its system one among the best banking systems in the globe.
The emirates, through the Central Bank of the UAE have become globally competitive and its main cities, especially Abu Dhabi and Dubai, have become commercial hubs attracting foreign investors and huge multinational companies. (Central Bank of the UAE, www.centralbank.ae/en).
The UAE Currency
The UAE currency is the Arab Emirate Dirham (AED), or dirham. Some of its abbreviations are DH or Dhs. One dirham,which is minted in coins, consists of 100 fils. Fils are minted as coins and are available in 1, 5, 10, 25 and 50 denominations.
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Dirham notes come in 5, 10, 20, 50, 100, 200, 500 and 1,000 denominations. Each bank note denomination have its distinctive color-brown, green, blue, purple, pink, green/brown, navy blue, and greenish-blue, respectively. The value of the note is indicated in both Arabic and English.
The dirham value in gold is 0.186621 gram. Since the dirham is fixed to the US Dollar at a rate of 3.67 AED to 1 USD, with a very narrow margin of -0.0027%, the exchange rate is much more stable compared with that of other currencies (http://www.exchangerate.com, 2010).
Dubai Online (2010) lists the following current exchange rates with other popular currencies:
Table 1. Current exchange rates
VALUE IN DIRHAMS (AED)
1 US dollar (USD)
1 Indian rupee (INR)
1 Euro (EUR)
1 British pound (GBP)
1 Moroccan dirham (MAD)
1 Bahraini dinar (BHD)
1 Kuwaiti dinar (KWD)
1 Omani riyal (OMR)
1 Egyptian pound (EGP)
1 Pakistan rupee (PKR)
1 Australian dollar (AUD)
1 Russian rouble (RUB)
1 Canadian dollar (CAD)
Monetary Policies in the UAE
The UAE owes much of its success in banking to enforcing tight monetary policies while maintaining an open and free economic zone.
The Nations Encyclopedia (2010) states that the notable linkage of the UAE dirham to the US dollar simply shows that crude oil is sold in US dollars and that domestic interest rates will also move in tune with the US interest rates.
As an open and free economic system, the government kept to a minimum its directives on how private sectors conduct their businesses. Except for oil companies and foreign banks, no direct taxes are imposed on profits earned by the corporation as well as on personal income. In addition to the fact that trade barriers and exchange controls does not exist, capital and profits earned by foreign business can also be moved from UAE to the home base without fees. Moreover, customs duties are not only low but also has a lot of exemptions and tolerant visa policies permits easy hiring of skilled migratory workers (www.dubai.ae).
Sultan Bin Nasser Al-Suwaidi, Governor of CBU, expressed his fears in his speech during the 18th World Conference of Banking Institutes (2009) that the global financial crisis may slightly "reduce the prospects for the UAE economic growth." To help lessen its impacts, he emphasizes on the following points:
The UAE monetary policy will continue its direction on maintaining low official interest rates;
Credit and banking policies will enforce "reasonable but low rate of credit expansion and restricted banking expansion;
In light of the global financial crisis, he predicts the following from the Central Bank of the UAE:
A move towards establishing single regulatory systems within central banks;
Stricter adherence to prudential ratios and higher penalties for excesses against the set prudential ratios; and
Tendency to develop banking systems with 100% reliance on local funding, which will give more prominence to conventional commercial banking versus the more innovative investment banking.
Comprehensive assessment of UAE banking practices is generally conducted by the International Monetary Fund (IMF) missions using available data provided by the country itself and self-assessment documentations.
The IMF 2003 Report on the Observance of Standards and Codes (ROSC) as cited by eStandardsforum (2010) reveals that while CBU "observes most good transparency practices regarding monetary policy," it also has its weaknesses. For instance, there has never been a public disclosure of the process of determining the amount as well as amount of annual net profits. At present, this policy hasn't been changed.
As a whole, the ROSC recommended for the CBU to reinforce their reporting methods, especially with regards to the banking decisions and operations.
The UAE has been reported to be among the countries with some of the best banking practices in the world. This reputation is largely due to the monetary system employed by the United Arab Emirates. In a growing economy like the UAE, monetary policies have the power to control its economy and have the government provide for the money that it needs.
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However, the recent 2008 global crisis show a dwindling of this confidence and loopholes in the monetary policy of the country were noted (Albastaki, 2010). The blog further opined that total monetary policy control had never been previously an issue due to an incorrect assumption that the "economy will always grow and the market will not fluctuate." The UAE then realized that it should have had total monetary policy control, specifically in controlling the interest rates, to deflect some of the negative effects of the inflation. Among the reasons, for which is the fact that the dirham is pegged to the dollar.
Monetary policies are used to control economic factors as unemployment, inflation, international trade, productivity, and investments. Even if the UAE have some abilities in its expansion policies due to the country's oil reserves, the UAE doesn't have a contractionary monetary policy which uses an increase in interest and tax rates (Albastaki, 2009). Although, the country may well be able to control other factors, if and when the UAE economy will mature and it still does not have total control over its contractionary monetary policy, one of its predicted results will be that the circulation of money will get out of hand.
Albastaki (2009) concludes that monetary policies should give total authority on money supply, expansion, and contraction policies for the economy to become truly stable.
On the other hand, Dr. Tarek Coury (2009) believes that the UAE will not be affected too much by the "deflationary trap" experienced by other countries. Since the UAE pegs its dirham to the US dollar, it lacks a contractionary monetary policy; hence, the CBU cannot control inflation rates and inflation rates, in turn, tend to be erratic.
Among its effects would we that "investment decisions on the aggregate level are made according to the real rate of interest" (Coury, 2009). When the dynamics in investments become unstable, the linkage of the dirham to the US dollar has its advantages in the long run because it ensures minimal monetary disturbances. Coury (2009) further purports that this set-up is especially beneficial for an emerging economy like the UAE.