AED to benefit from renewed USD, tourism sector’s strength

The United Arab Emirates dirham (AED) was introduced in 1973. But since 1978, the dirham was officially pegged to the IMF’s special drawing rights, meaning that in practice, it is pegged to the US dollar.

The peg rate was established in 1997 at 3.6725 dirhams for 1 USD. As such, when looking at the dirham’s fluctuations in value, it makes sense to look at the dollar’s strength or weakness.

Lately, the dirham is strong because of two major global and local trends. On the one hand, the US dollar rallied from mid-2021 until the end of last year. On the other hand, the local tourism industry is recovering fast to pre-pandemic levels and is forecast to continuously increase in the years ahead.

The US dollar rallied on the back of the Fed’s policy tightening

Because of the peg, it makes sense to look at the US dollar to assess the dirham’s strength or weakness. The Dollar index (DXY) reflects a strong dollar between 2021 and 2023, as the Fed kept tightening the monetary policy.

As such, the dollar’s strength translated into the dirham’s strength. But why would a country choose to peg its currency to the US dollar?

For several reasons. One would be to import the stronger currency’s attributes, such as low inflation. Another is that the peg stabilizes the exchange rate between countries as it becomes more predictable. Finally, the UAE can reduce the volatility of its oil exports by pegging the AED to the US dollar.

DXY chart by TradingView

UAE tourist arrivals is forecast to increase between 2023 and 2028

Besides the oil industry, tourism is a major contributor to the country’s gross domestic product. 4.1 million people visited Abu Dhabi in 2022 alone, a 24% increase compared to 2021.

Moreover, the number of international tourist arrivals is forecast to increase 71.74% by 2028.

The war in Ukraine led to Western nations imposing restrictions on Russia. Travel restrictions led to Russians holidaying in UAE, and spending their rubles there, further contributing to the dirham’s strength.

All in all, because the AED is pegged to the US dollar, it makes sense to look at the Fed’s actions to asses the future strength or weakness of the local currency. As long as the peg holds, other factors have little or no influence on dirham’s volatility.