The logic behind the UAE’s pursuit of US currency swaps

To swap or not to swap? Last month the UAE let it be known that it had expressed interest in dollar swap lines with the US Federal Reserve.

The request comes from a part of the world synonymous with providing quick money for bailouts. Think Adia’s injection of $7.5 billion into Citibank in 2007 or the QIA’s £4 billion into Barclays in 2008.

Nearly 20 years on, the circumstances are clearly different. It is the economies of the Gulf countries that are under the spotlight thanks to the blockade of the Strait of Hormuz. Thani Al Zeyoudi, minister of foreign trade, has subsequently said the UAE’s enquiry is about joining an elite group. But it raises the question: why ask?

After all, UAE central bank net foreign reserves rose to about AED850 billion ($230 billion) in February, almost double those held at the end of 2021.

A currency swap line is an agreement between two central banks to exchange currencies. If the US acquiesces, the UAE central bank can exchange dirhams for dollars with the Federal Reserve and supply these to its domestic financial system to alleviate any dollar shortages.

The list of institutions that have permanent swap arrangements with the US Federal Reserve is small and select – and typically globally significant in terms of financial stability: the central banks of Canada, Japan, Switzerland and the UK, as well as the European Central Bank.

The temporary mechanism is typically used only in emergencies, most recently with Argentina last year. The UAE is not remotely in that terrain.

There is surely another reason behind the country’s expression of interest in swaps. The UAE and its peers in the Gulf Cooperation Council hold sizeable amounts of US debt in the form of Treasury bills and bonds. At the end of February, just as the US-Israeli conflict with Iran started, the UAE had $120 billion and Saudi Arabia $160 billion in US treasuries, little changed on a year earlier.

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That data comes from a compilation of those states with the most sizeable holdings. A more detailed readout, which captures other wealthy Middle Eastern countries such as Qatar and Kuwait, comes out half yearly and in arrears. But the most recent details overseas holdings of US debt at the end of June last year – an aeon ago.

Given the scale of the disruption to GCC economies since the end of February, it seems likely that there will have been sizeable disposals of some of these assets to fund reconstruction and rearmament, in addition to day-to-day spending. Or that disposals are being considered. That’s why you have reserves.

If there is any issue with liquidity – and we have seen only limited signs of strain in the form of rising UAE interbank rates – there is an alternative to selling assets. The Federal Reserve operates a foreign and international monetary authorities (Fima) repo facility. This fulfils nearly the same function as a swap line in that it allows near instantaneous pledging of bills and bonds in return for cash. And, for a small fee, you get to keep the assets.