It now seems inevitable that the GCC’s monetary union (MU) project will be delayed. The ground has already been prepared, so to speak.
Emilie Rutledge | November 2, 2007
It now seems inevitable that the GCC’s monetary union (MU) project will be delayed. The ground has already been prepared, so to speak. The central bank governors of the bloc’s two largest economies, Saudi Arabia and the UAE, recently said that the 2010 deadline is “very ambitious” and that the project may be postponed to “2015 or beyond”.
Few will be surprised. In conjunction with the lack of tangible progress, there has recently been a series of setbacks. The first was Oman’s decision to opt out; clearly a psychological, if not economic blow. The second was Kuwait’s decision to revert back to a trade-weighted exchange rate peg. Between 2003 and mid-2007 it had aligned itself with all other states by officially pegging to the dollar (albeit with a small band of flexibility).
Potentially the most significant setback, however, was a collective decision in September which permitted member states to tackle inflation independently. If this translates into diverging monetary policies, it will jeopardise (even further) the stability of bilateral exchange rates, one of the few monetary convergence areas where the GCC has been doing well.
It may well be the case that the current oil price boom has dampened the desire (need) for economic integration and consequently a single currency – the pinnacle of integration – has been placed on the back-burner. The GCC’s commitment to MU was strongest in 2001 at the tail-end of a protracted period of low oil prices, lacklustre GDP growth and declining per capita incomes in many states.
It is possible that an announcement will be made just prior to or during this December’s GCC summit. Probable reasons for the delay include the fact that the timeframe is (now) too tight, and/or that diverging inflation rates of approximately 10 per cent – Qatar and Saudi Arabia’s official inflation rates were 11.8 per cent and 2.3 per cent respectively in 2006 -make the task of meeting this convergence criterion too difficult.
Little preparation
While the first argument may now be true, it is only so because so little has been done to prepare for the monetary transition; for instance, no agreement has yet been reached on the mandate and role of a GCC central bank let alone its location, neither have convergence criteria/targets been officially agreed upon and endorsed.
The second argument holds more weight, but if regional commitment to MU were strong enough, inflation rate differentials could be tackled. In the years prior to the euro’s launch there was also considerable inflationary divergence, but post-Maastricht this decreased rapidly from a high of 20 per cent to around 1 per cent by 1999.
Although most participating states have outsourced their monetary policy to the Federal Reserve and subsequently aren’t able to use interest rates to reign in inflation, there are other ways. These include holding back on fiscal spending (staggering government financed infrastructure upgrades), implementing more extensive price controls (for instance rent-caps) and absorbing liquidity through the issuance of bonds.
If and when an announcement does come, it is more likely to be a deferral than a complete abandonment. This will partly be for face-saving reasons, but primarily because GCC MU has been such a long-standing ambition, first mentioned in 1982 and more recently recommitted to in the New Economic Agreement of 2001.
Turning to the question of whether a delay matters, in many respects the short-term answer is no. A postponement will not harm current levels of economic growth and neither will it deter capital retention. In addition, many analysts argue that a GCC MU would only have marginal utility, because a) intra-regional exchange rates are already reasonably stable, and b) intra-regional trade is seen to be limited. Thus, participating economies would only see small gains from two key MU advantages: the elimination of exchange rate risk and the reduction of transaction costs.
Nevertheless, even if the potential trade benefits arising from a GCC MU are initially small, they should not be discounted. If hydrocarbons are factored out, intra-GCC trade is not as insignificant as often assumed – it stands at around a fifth of the total. In addition, trade gains resulting from currency unions are often considered “endogenous” – trade will increase as a result of the union, regardless of its level prior to the union.
In addition to the direct (as a consequence of MU) benefits there are a range of indirect (as a result of the necessary preparations and policy reforms in the lead-up to MU) benefits, and it is these that will be bring the most advantages to the GCC.
Indirect benefits will arise from the creation of a GCC common market, establishing a pan-GCC economic data-gathering institution, tasked with collating and standardising national statistics in order to measure monetary and fiscal convergence, and the implicit need for budget transparency and accountability. Many of these institutional and policy reforms necessary in the lead-up to MU, or the process of preparing for it, are likely to enhance business sector confidence, encourage greater levels of intra-state investment, deepen financial markets and encourage more FDI. These outcomes would all be beneficial for the GCC’s economic diversification endeavours.
Not seeking to downplay the prudent investment and diversification measures all states are making with their current oil windfall revenues, private sector job creation remains one of the biggest challenges facing the region. In order to defuse the “unemployment time-bomb”, hundreds of thousands of non-oil dependent private employment opportunities will need to be created during the next decade.
Therefore any policy including MU that is seen to aid and abet private sector confidence and growth should be seriously entertained. Of course a GCC common market and statistical agency could exist without there ever being a “Gulf dinar” in circulation. But if the intention to form a single currency acts as a catalyst, a carrot on a stick if you will, why not use it?
Comment: A bubbling pot
– Andrew Shouler, Deputy Managing Editor
For governments of the region struggling with declining currencies and domestic inflation, there are decisions on the table. “Given the UAE’s rapid and sustained economic growth, nominal appreciation of the dirham is required to allow the real exchange rate to move towards equilibrium value,” says Syed Basher, a regional economist. Simply, that means revaluation. The arguments about the dollar peg have been simmering for some time, given that exchange and interest rates seem too low for the region’s hothouse conditions. In an HSBC survey issued last week, 39 per cent of regional executives were reported as saying that removing the dollar peg would have a beneficial effect, compared with 18 per cent saying the opposite. A Gulf News poll last week produced results suggesting that 62 per cent of residents want a GCC single currency.
Of course, that doesn’t necessarily mean the issue is coming to the boil. Saudi Arabia this week tightened banks’ reserve requirements while cutting official interest rates in line with the Fed. It was a demonstration of a monetary dilemma which, obscure as it might seem, impacts all those working in this region. But we all know what they say about those who can’t stand the heat.