Oman’s decision late last year to opt out of the GCC currency union was undoubtedly a political setback, but Kuwait’s unilateral decision early last week to revert back to an undisclosed basket peg represents a potentially far more complicated technical obstacle.
Emilie Rutledge | May 26, 2007
A GCC single currency minus Oman would be, and could still be, a perfectly viable and potentially advantageous union. Oman only contributes five per cent of the GCC’s total GDP. However, Kuwait’s decision to peg to a basket of currencies weighted by the country’s main trading and financial partners could complicate the bloc’s monetary convergence process.
The fixing of bilateral exchange rates is a relatively minor issue compared to other currency union prerequisites. Establishing a common market and a pan-GCC central bank is going to take concerted effort and political will. So too will working towards and sticking to a set of commonly-agreed convergence targets for inflation, fiscal deficits and debt. Yet stable bilateral exchange rates – all six pegging to the dollar – had been one of the GCC’s few currency union related success stories. The latest decision by Kuwait seems to have jeopardised even this one.
However, before the currency union is written off, several factors need to be considered. The first is this: for many years, even before Kuwait’s move to a dollar peg in 2003, all GCC currencies had been remarkably stable vis-a-vis one another. It is not given, therefore, that Kuwait’s move will cause its dinar to fluctuate widely against the bloc’s other currencies. Secondly, the European Monetary Union (EMU) countries only insisted on bilateral exchange rate stability two years prior to the electronic launch of the euro. The GCC, therefore, still has time to reach a consensus on the issue. Therefore, the appreciation of the Kuwaiti dinar does not necessarily preclude achieving stable exchange rates in preparation for monetary union – a key criterion for monetary union. Nevertheless, it indicates Kuwait’s desire to remain flexible and to retain national autonomy over its exchange rate policy.
Whose interest?
Again we must ask, as we did after Oman’s surprise announcement, will Kuwait’s move be a catalyst for other states to put their own sovereign interests before the bloc’s ‘common interest’? Before Kuwait’s unilateral decision, the GCC central bank governors meeting in Riyadh last month had highlighted the diverging interests on how to proceed with their respective and ‘collective’ currency peg(s). With the dollar hitting an all-time low against the euro and pound, the issue of a collective revaluation was said to have topped the agenda.
However, leaders were unable to agree on how much their currencies should collectively revalue by, and as a consequence, agreed to keep exchange rates unchanged. Obviously, and with the benefit of hindsight, this was much to the disappointment of some participants. But it is not only Kuwait that seems to be questioning the utility of attempting to act collectively.
According to one official at the recent Riyadh meeting, the decision to maintain the status quo was to safeguard the stable bilateral exchange rates in preparation for the currency union.
However, if all states had agreed to, say, a 15 per cent revaluation, this would have meant that bilateral exchange rates would still have been stable. A more likely reason for keeping rates the same was disagreement on the merits of a revaluation per se.
The discord is in large part due to the increasing divergence in inflation rates within the GCC and differing economic development strategies. According to some estimates, Saudi Arabia’s inflation rate was only 2.3 per cent in 2006 while Qatar’s was 9.2 per cent.
Criteria
The GCC had provisionally agreed to accept EMU-style convergence criteria back in 2005. Part of this necessitates keeping inflation rates within two per cent of the best performing economies. But now even these are being increasingly questioned.
His Highness Shaikh Mohammad Bin Rashid Al Maktoum, Vice-President and Prime Minister of the UAE and Ruler of Dubai, said on his trip to Seoul that the UAE government would have to reassess its commitment to the currency union if it were deemed not to be in the best interests of the national economy.
Qatar is now arguing that the bloc should instead focus on core inflation, which strips out the impact of soaring rents, rather than headline inflation – the conventional measure. Kuwait’s decision has again highlighted the bloc’s diverging interests and differing priorities. It seems clear that finding consensus on joint monetary policy is becoming more, not less difficult as the 2010 deadline draws nearer. There is a strong possibility that Qatar and the UAE will at some point revalue; until then the jury’s out.