To dedollarise, Saudi and the UAE need to depeg from the dollar and float the riyal and the dirham
Saudi's first yuan loan and reported use of the dirham to dedollarise international trade ignited a conversation about the prospects of Gulf countries dedollarising part of their trade. To examine such propsects and their business implications, many issues need to be discussed.
Both Saudi and the UAE have a fixed exchange rate and their currencies are pegged to the dollar. While this has historically provided stability, it may no longer be a sustainable option for countries interested in economic diversification and transformation. The dollar peg made sense when the two economies were heavily reliant on energy sales. Until recently, the UAE and Saudi GDP relied on selling energy and the government spending the revenues on public infrastructure and procurement. Pegging helped stabilise the political and economic systems and financial transactions with the world, which would have been difficult otherwise. Up until a few years ago, Saudi did not even have a proper central bank with a monetary policy. The government had no fiscal tools to manage the economy and it relied on energy revenues to fund itself and achieve economic growth.
Today, to diversify the economy, there is a growing need to enact fiscal and monetary instruments capable of catering to different industrial and sectoral interests. For the Chinese yuan to have a larger share of the Saudi or UAE reserves, more countries need to accept the yuan as a medium of exchange.
More importantly, the dirham and the riyal values cannot be firmly fixed to the dollar reserves and need to depeg from the dollar or diversify the basket of currencies for the peg. However, this risks destabilising the local currencies as they become subject to shocks both in the yuan and the dollar. Hence, floating the currency may be needed for the markets to adopt to such fluctuations when they occur without substantially affecting business operations. Otherwise, the Saudi and the UAE economies risk being caught in the crossfire of the weaponisation of these currencies for national security objectives and other countries' economic and monetary policies.
To enable exports to the region and beyond and gain some competitiveness, floating the currency will help boost exports and compete with weaker currency economies that undervalue their currencies to sustain an export-led development model.
Business implications
The road ahead for dedollarisation in Saudi and the UAE will be longer than some claims suggest. There will be plenty of signals beforehand. Reaching a point where non-dollar currencies gain a significant share of Gulf trade volume will depend on the willingness of these countries to depeg their currencies from the dollar and establish a more flexible exchange rate regime that caters to the new economic activities that are planned to drive economic growth.
Tensions with the US are going to become a recurrent theme of the process as both assess a divergence in priorities and national interests. Nonetheless, the dollar will remain a key currency for trade for these countries insofar the weaponisation of the dollar does not substantially undermine the UAE and Saudi national agendas. Hence, business disruption will remain minimal unless geopolitical escalations create an urgency for swift policy changes.