A historical analysis of GCC economic performance reveals little evidence of any economic convergence taking place. Inflation differentials between the five economies remain high, and in fact have widened since the beginning of the recent oil price boom.
Emilie Rutledge | May 5, 2007
At the summit of GCC central bankers held last month in Riyadh, little progress was made in terms of making preparations for the Gulf common currency. Despite the 2010 launch date fast approaching, all the central bank governors could do is urge GCC leaders to expedite the process.
In reality, as Saudi Arabia’s central bank governor Hamad Saud Al Sayyari recently admitted “the original target [date]…has become tight.” In fact there has been little tangible progress since the signing of the 2001 GCC New Economic Agreement. The policy preparations for establishing a viable currency union.
Customs union
In 2003 a milestone in GCC economic integration was reached with the launch of the customs union, harmonising external tariffs to five per cent and removing intra-regional ones. However, the signing of bilateral free trade agreements (FTAs) with the US by Bahrain and Oman meant that the final stage, involving the abolition of customs collection functions at intra-GCC border offices, could not take place as scheduled at the end of 2005. The issue has yet to be resolved, and the finalisation of the customs union was set back by two years.
The final communique of the 2006 summit said that a common market would be in place before the end of 2007. Without the common market, many of the benefits of a single currency will not be realised. Despite the fact that GCC leaders are taking some pro-active steps, such as enacting legislation to facilitate the free movement of labour and capital, it is doubtful whether it will come into being this year.
In addition to the delay in the customs union at the 2004 summit, it was agreed by the GCC leaders that the deadline for completing a unified pension and social security system could be as late as 2010.
It is hard to envisage how a single monetary policy and currency for a regional bloc can be implemented without a single central bank. In 2005, after consultations with the European Central Bank, the GCC announced their intention to establish a regional central bank. However, more recently they seem to be backtracking to their original plan to retain national central banks and for governors to convene on a regular basis to decide on monetary policy for the bloc.
Controversial
The establishment of pan-GCC institutions requiring the devolution of some national decision-making powers, also appears to be a sticking point. Even the potential location of a GCC central bank seems to be controversial.
The IMF considers the creation of a GCC Statistical Agency to be of serious urgency for the currency union project. Yet, creating a ‘Gulfstat’ is not even on the agenda.
Without improved and harmonised data for the region, it will be hard to judge any progress in meeting convergence criteria and to make monetary policy decisions based on the economic conditions across the bloc. At a meeting of GCC central bank governors in 2005, it was provisionally agreed that they would adopt convergence criteria mirroring those of Eur-ope’s Maastricht criteria. However, they have yet to be officially endorsed. Instead, the GCC leaders called for more time at the 2005 summit, and disagreement over the targets remains. The fiscal and monetary convergence criteria include inflation and interest rate convergence targets, capping budget deficits at three per cent of GDP and keeping government debt to below 60 per cent of GDP.
While there are no problems in terms of exchange rate stability and interest rate convergence – not surprising considering the long standing de facto pegs against the dollar – there would have been difficulties in meeting all the other criteria. A historical analysis of GCC economic performance reveals little evidence of any economic convergence taking place.
Inflation differentials between the five economies remain high, and in fact have widened since the beginning of the recent oil price boom. Analysis shows that there are two inflationary blocs within the GCC, experiencing significant inflation rate differentials: a low-inflation bloc (Bahrain, Oman and Saudi Arabia) and a high-inflation bloc (Qatar, Kuwait and the UAE).
Here, the onus will be on Qatar and the UAE in particular to tackle their respective inflation rates – somewhat hard without independent interest-rate setting powers. Qatar now argues that it is better to use core inflation as a convergence target, rather than headline inflation CPI, which does not include the soaring price of property and rents.
Some of the inflationary pressures in the UAE, Qatar and Kuwait are due to the collective peg against the dollar, which is dropping fast against other international currencies, many of which are important trading partners for the region, like the euro-zone. Controversy over the dollar peg has appeared to suggest disharmony, with the UAE and Kuwait calling for a more flexible exchange rate regime, but Saudi Arabia and Bahrain preferring to stick to the dollar peg.
Uncertainty regarding the future choice of exchange rate regime for the region was undoubtedly a factor in Oman’s decision to opt out of the currency union.
Deficits
In the past budget deficits have frequently breached the three per cent to GDP ratio, sometime reaching double digits. Only in the case of Saudi Arabia did this translate into large levels of public debt, reaching as high as 102 per cent of GDP in 1998. Since then, Saudi Arabia has used its recent oil windfall to pay back a lot of debt, and it is now well within the criterion, but the cyclical nature of GCC fiscal policy leaves government budgets highly vulnerable to oil price swings.
The GCC states must adopt prudent policies if they are to be able to meet such convergence criteria. Meeting convergence criteria as well as creating pan-GCC institutions will inevitably require concerted political will. The degree of political commitment among GCC leaders with regard to the process of economic integration and the single currency may have come into doubt.
Indeed, issues such the slow progress to date, the signing of bilateral US FTAs and Oman’s opting out tend to suggest a lack of political motivation. It seems that as oil prices have risen, like so many times before, economic reforms are put on a back burner, particularly those that will inevitably entail some adjustment costs.
Yet, without the aforementioned policy preparations, the viability of the currency union project as a whole may be called into question. The self-imposed deadline is quickly approaching. The GCC leaders may choose to acknowledge that, in order to ensure a viable and sustainable currency union, a more realistic timetable and credible launch date for the single currency needs to be adopted. Otherwise, the economic integration project would be vulnerable to losing considerable credibility, and confidence in the economic policymaking of the region could be affected.