Emiratis ‘must be steered into private sector’

The public sector employment market is reaching ‘saturation point’ and focus should be on education and subsidising the private sector.

https://www.thenational.ae/uae/emiratis-must-be-steered-into-private-sector-1.514367

June 6, 2010 | The National | Kareem Shaheen

The Emirati public sector employment market is reaching “saturation point” and the Government should focus on educational reform and the subsidisation of private sector wages rather than Emiratisation quotas, according to a new policy study. The state can no longer act as an employer of first and last resort and public sector jobs should not be part of the “social contract” by which the Government distributes oil wealth to its nationals, according to the radical report to be published later this year.

Instead, the Government should concentrate on diversifying the economy, greater career exploration in school and college, subsidising the salaries of Emiratis in the private sector and increased support of state-owned private companies. The study was compiled by researchers from United Arab Emirates University (UAEU) and will be published during the summer in the Middle East Policy journal. The authors present a range of solutions to boost employment and communicate the message that over-reliance on the Government for employment is not feasible, drawing on wide-ranging employment research.

Concern has been rising over Emirati unemployment, which has reached 14 per cent in the capital. In January, the director general of the Abu Dhabi Education Council called the figure “alarming”, saying it demanded urgent attention. Emiratis make up just four per cent of the private sector workforce, compared with 52 per cent of the public sector. “There is a growing realisation within the region that public sector bureaucracies have reached the saturation point. They can no longer act as an employer for first and last resort,” the study says.

Ingo Forstenlechner, assistant professor of human resources management at UAEU, and one of the paper’s authors said: “The dream of most of my students is to work in the municipality. That’s not going to help the country and it’s not going to be possible.” His co-author, Dr Emilie Rutledge, an expert on Gulf fiscal policy, is an assistant professor of business and economics at the same college. Feddah Lootah, the acting director general of Tanmia, the UAE’s employment agency, said the deep divide between the public and private sectors was to blame for Emiratis’ preference for government jobs.

Experts often argue that the higher wages, shorter working hours and greater job security of the public sector act as incentives that drive locals away from private companies. “Not only this, but they continue to encourage the private sector to import and recruit cheap foreign labour under the umbrella of competitiveness,” said Ms Lootah. Under-15s make up roughly 39 per cent of the Emirati population in the capital, and those between 20 and 40 constitute 40 per cent. Emiratisation experts argue that the public sector cannot absorb such large numbers.

This new approach is necessary because many long-standing employment policies have not reversed the absence of nationals in private companies, the paper says. Employers still lack confidence in the country’s education system. A survey by the Mohammed bin Rashid Foundation found that just half of Arab executives felt that nationals were competent enough to work in their industries. This was because the education system rarely adhered to the needs of private sector employers in the Gulf, said Ms Lootah, which “was at the core of these countries’ dilemma of importing expatriate labour to bridge the vacuum of qualified human resources”.

This gap was still contributing to the unemployment of new national graduates, she added. Almost double the number of students in Grade 12 in the UAE choose the humanities track instead of sciences, according to the Ministry of Education, contributing to this gap in expertise. Many attempts at diversification have met with limited success. Manufacturing is not viable because of the small size of Gulf markets, and job categories like hairdressing and waitressing are deemed inappropriate for the local population, the paper says.

Quota systems, which require private companies in some sectors to hire a set percentage of Emiratis, call into question the “region’s business-friendly persona”. Affinity towards the government sector had contributed to unemployment because many nationals preferred to stay out of work for years rather than work at a private company, said Dr Forstenlechner. One solution, he said, was to strengthen state-owned private companies. Another was to subsidise private sector employees from the UAE, “topping up their private sector salary” or giving them government pensions.

He said the UAE’s significant investment in educational reform and new university campuses were good first steps. The country’s nuclear programme has won praise for including a development plan that ensures the deep involvement of Emiratis. Shaikha Eissa, a public sector employee at the Ministry of Social Affairs, who used to work for a private company, felt that concern that the public sector was “saturated” was overblown, but said she would not mind working for a private company again.

“Both types of jobs are enjoyable, I don’t know why people make a big deal out of it,” she said. “As Emiratis, we aren’t scared of the private sector. There is no constant worry that the company might fail, because our Government stands by us even if we are in the private sector.” She acknowledged that working in a government job could often be comfortable, but “work in the private sector is enjoyable and has creativity, and you can play a big role in the company”.

Ms Eissa said she preferred working at the private company as it had better long-term incentives and individuals were more likely to shine. While the public sector constantly needed new blood to replace its retirees, “if I had the chance, I would work in the private sector because it has a future.”

Time to rethink dollar peg

The UAE’s decision to opt out of the planned GCC monetary union is a fundamental setback to the planned Gulf single currency, and illustrates a deep concern at the heart of all monetary unions – that of ceding sovereignty over economic and monetary policy.

by Emilie Rutledge | May 20, 2009

The UAE’s decision to opt out of the planned GCC monetary union is a fundamental setback to the planned Gulf single currency, and illustrates a deep concern at the heart of all monetary unions – that of ceding sovereignty over economic and monetary policy.

The announcement from Riyadh that the Kingdom – already home to the GCC Secretariat – will host the GCC central bank, clearly illustrates its desire to exert control over the monetary union’s decision making bodies.

This, of course, is of particular concern to its smaller neighbours, as exemplified by Abu Dhabi’s response. It indicates that in a future monetary union, the Kingdom might attempt to steer future joint economic and monetary policy to suit its own domestic economy.

Objectively speaking, the UAE had the strongest case to host the bloc’s central bank. With its high standards of regulatory quality, excellent banking infrastructure and a critical mass of banking institutions and expertise, the UAE has justifiably earned its international reputation as the Gulf’s financial centre. Indeed, other central banks in the region, such as Kuwait, also appeared to favour the UAE as a ‘safe’ location.

Whether or not the loss of national control over economic and monetary policy is perceived as too burdensome by the smaller GCC states remains to be seen.

With Oman already out of the picture, Kuwait’s peg to a basket and Qatar’s on-off relationship with the Kingdom, could a Bahraini-KSA monetary union take place in 2010? Even this may be unlikely, recalling that Bahrain, not so long ago, forged ahead unilaterally with a US Free Trade Agreement.

For the UAE, the utility of its dollar peg is likely once again to resurface, for it is no longer a requirement of the GCC integration process. A move to a trade-weighted basket peg, à la Kuwait, would perhaps better serve the UAE’s economy.

Your dinar is in the oven

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.

Single currency at a crossroads

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.

An inconvenient truth

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.

Gulf monetary union is a cracking project?

Although few observers will be surprised if the GCC’s planned single currency (perhaps ‘Gulf Dinar’) doesn’t come into circulation on schedule in 2010, most will have been by Oman’s decision to unilaterally opt out.

Emilie Rutledge | December 16, 2006

Although few observers will be surprised if the GCC’s planned single currency (perhaps ‘Gulf Dinar’) doesn’t come into circulation on schedule in 2010, most will have been by Oman’s decision to unilaterally opt out. This is primarily because Oman, the poorest member of the bloc, looked set to reap considerable dividends from entering into a monetary partnership with its economically larger and wealthier neighbours.

In 2005, the Sultanate’s GDP per capita income was 63 per cent of the GCC average and its economy constitutes just five per cent of the GCC’s total GDP. Evidence from the euro zone reveals that increased intra-regional FDI, combined with structural grants and subsidies, fostered a process of catch-up, which has helped reduce income disparities between member states.

Indicating that the general lack of preparation was behind Oman’s decision, Deputy Economy Minister Abdullah Al Hinai said that the 2010 deadline was unfeasible because key prerequisites such as a common market have yet to be established.

However, last week’s final GCC summit communique stated that leaders had agreed to finalise the customs union and ensure that all requirements of a common market will be fulfilled by the end of 2007. Furthermore, the main reason for the delay in the finalisation of the customs union was the unilateral decision by Oman, preceded by Bahrain, to sign a free trade agreement with the US. Bahrain’s move in particular was met with considerable disquiet, and was considered to be against the spirit of previously signed GCC economic agreements.

The imperative to diversify is much stronger in these states nevertheless and, if one looks at the time it is taking the GCC as a bloc to negotiate an FTA with the EU, their decisions to act unilaterally are more understandable. Policymakers in Muscat cannot afford the luxury of taking years to implement economic reforms.

In many respects, Oman’s announcement was the only concrete decision made regarding currency union at last week’s summit. GCC leaders did not officially approve the euro-style convergence targets which central bank governors had agreed upon amongst themselves. Nor was any decision reached on the mandate for, or location of, a GCC central bank.

At the 2001 GCC summit convened in Muscat, leaders set out in unambiguous terms their intention to establish a currency union, yet apart from Kuwait’s move to the dollar-peg and the launch of the customs union in 2003, little progress has taken place.

Oman is perfectly justified in not wanting to join an ill-prepared monetary union, but instead of opting out altogether it could have set preconditions; not committing to join, for instance, until a common market was successfully up and running.

Decision timing
Why then, has it made such a decision now?

Earlier this year the GCC states provisionally agreed on several convergence targets, including capping budget deficits at three per cent of GDP, public debt at 60 per cent of GDP and all states holding enough foreign exchange reserves to cover four months’ imports. It is hard to see how any of these targets could have contributed to Oman’s decision, as it was unlikely to face any serious difficulties in meeting them.

In 2005, Oman’s fiscal surplus stood at 11 per cent of GDP, public debt is well under the limit, and its foreign exchange reserves covered more than five and a half months’ imports. The Oman-US FTA, signed in late 2005, demonstrated Muscat’s desire to integrate further into the global economy and diversify its economic base. It also revealed that Oman is unwilling to compromise what it perceives as its optimal national economic interests. It indicates that the loss of some economic policy-making sovereignty, necessary for a viable currency union, may be too high a cost for it to bear. The most likely reason why Oman has opted out now, however, is a conflict of interest on the future choice of exchange rate regime for the unified currency. Oman’s economic diversification strategy going forward may well be best served by a relatively weak currency.

On the other hand, states such as Kuwait and Qatar are suffering from “imported inflation” due to the declining dollar, and are likely to want any future unified currency to strengthen vis-à-vis the dollar. By being part of a stronger unified currency, Oman’s nascent non-oil export oriented industries will suffer because its products will be less competitive. And as a tourist destination, Oman will be less attractive to higher-end European visitors if euros buy fewer Gulf Dinars than they currently do Omani riyals.

There is, of course, a real danger that by opting out Oman could ultimately lose out. Oman has significant trade levels with several GCC states, and if a Gulf Dinar does come to fruition, it will continue to face transaction costs and exchange rate risks, regardless of it being a member of any future common market. Last year, Oman received just 3.6 per cent of the total GCC FDI inflows. It may receive even less in the future, as international investors are likely to buy Gulf Dinar-denominated assets as a hedge against the possibility of the currency being used to invoice oil and gas sales.

Likely union
A currency union among the other five states remains a distinct possibility, and would be economically viable. They are on the way to meeting many of the optimal currency area criteria conditions which economists argue are necessary for a given region to be suitable for currency union. Yet, and as with the euro zone, political commitment is by far the most important criterion. As the deadline approaches, necessary reforms which will involve devolving some decision-making powers to pan-GCC bodies, coordinating economic policies, improving data transparency, exercising fiscal restraint and opening up budgetary plans to outside scrutiny, may be deemed politically unpalatable.

Consequently, Muscat’s move may become a catalyst providing a convenient excuse for other states to follow suit. A more likely eventuality is a collective agreement to defer the launch date by a few more years. Following Oman’s announcement, Saudi Arabia’s Finance Minister, Ebrahim Al Assaf, declared that the five remaining states could “extend the 2010 deadline if faced with more obstacles.”

Casting off from the dollar

So the GCC central bank might come to Abu Dhabi. The statement has since been retracted, but it was a headline last week, and would be some sort of coup for the UAE.

September 23, 2006 | Gulf News | Andrew Shouler

https://gulfnews.com/business/sectors/banking/casting-off-from-the-dollar-1.256170

For many observers, however, the bigger story lay underneath in any case, in the apparent confirmation by Central Bank Governor Al Suwaidi that the US dollar will be abandoned in its role of currency peg, not by 2010, but by 2015.

If confirmed, it raises all sorts of questions, not just for the monetary regime and economies of the Gulf countries, but maybe for the dollar itself, hitherto pretty much unchallenged as the world’s unofficial reserve currency.

Central banks around the globe have stockpiled it in their reserves, and the Asian countries running huge trade surpluses have found themselves recycling those funds back whence they came, not only for investment opportunity but to help cover their own exposure.

The US has been able to run increasingly heavy deficits accordingly. Not even the triumphalist emergence of the euro took too much of a shine off the dollar’s pre-eminence. But if the creditor countries, in whole or in part ditched their traditional benchmark, this perpetual motion model might be under threat. It may be an unduly alarmist view, but it’s worth scouring around for some answers to the general proposition of a dollar implosion.

Some of the facts are plain and their implications unavoidable. US deficits imply dollar weakness for some time to come. “Some are suggesting that one of the reasons for current euro and sterling strength is that oil surpluses are [already] favouring those currencies,” Philip Khoury, Head of Research at EFG-Hermes, observes.

“Likely US slowdown driven by weaker consumption is likely to [bring it down further] due to lower interest rates.” The outlook seems no better. “Rising external indebtedness does not portend well for the dollar’s role.”

There are many who would agree with that prognosis. “We continue to be dollar bears over the medium-term”, says Steve Brice, Head of Regional Research at Standard Chartered. Even so, the idea of breaking easily from the dollar meets with little bullishness. The relationship has been in place for so long, there is a certain comfort zone involved. Jasim Ali, Head of the Economic Research Unit, University of Bahrain, believes “GCC states tend to avoid change and risks. I think the GCC states would most likely avoid other arrangements, despite some of the statements made.”

The picture may be muddier than that, however, insofar as the GCC states have differing levels of motivation. “States that are more diversified (like Oman, Bahrain and the UAE) have less of an incentive to keep the dollar peg,” opines Jane Kinninmont, economist at the Econ-omist Intelligence Unit. That’s an issue which may still delay monetary union anyway, she suggests.

There’s another reason to be cautious. “I’d be surprised if the single currency were to float,” Gulf analyst Robert Powell, also of EIU, remarks. “It would expose the single currency to the vagaries of the oil market, would create uncertainties for firms looking to invest in the GCC, and could also be a setback for those states’ efforts to diversify their economies.”
So the prospect of setting the GCC currencies free may be dimmer than supposed. But what if it did happen? Would that be serious?

Any such shift, particularly if oil were to be priced in different currencies, may exacerbate the dollar’s downtrend, Brice at Standard Chartered confirms. “To some degree this would be a fundamental issue, in both current account and capital account transactions from the region. However, it could also have a significant psychological impact, as a step towards a shift in hegemony.”
That said, there is no obvious replacement at this juncture, he continues. “Europe and Japan are still struggling economically, and the Chinese yuan is still a long way from being a reserve currency.”

Therefore, the US dollar is likely to remain kingpin for years to come, it would seem. Brice reiterates the importance of the US to the rest of the world. “As such, we expect any such reduction in reliance on the dollar to be gradual.”

Amid this conjecture, the bolder line is to say that the hour of the independent regional currency is fast approaching. “I feel it is about time the GCC states allow their common currency to float. This would enable them to really determine their competitive situation in the world market,” says local economist and entrepreneur Abdullah Sharafi.

Emilie Rutledge, visiting professor at the UAE University, goes further, anticipating the creation of a Gulf ‘dinar’ which might itself displace the dollar in central bank accounts. “From a geo-political context, the dinar may be perceived as more morally acceptable than holding the US dollar, and also a more Islamically-acceptable currency to hold either in reserve or indeed even to peg to.” That thought cannot be too far from the authorities’ minds, although it puts the regional order and international relations right into the melting pot.

Yet, while the system of the US swapping paper greenbacks for manufactures and commodities is losing viability, it will still be the decisions made by China which will carry far greater weight, Rutledge maintains. At the same time, a certain fatalism applies. Sharafi argues: “The USA is a superpower, behaves like a superpower, and is treated as a superpower. These monetary changes would not affect its position. The two are just not linked.” Whatever lies ahead, uncertainty prevails for now. Once the GCC countries have resolved the currency matter, clarity should ensue.

“It is important that the central bank’s intentions are flagged some time in advance, so businesses can protect themselves against the different currency and interest rate exposures they will face,” says Brice, ushering in the risk management story.

Risk indeed there is, but the dollar might itself sail serenely into its sunset. And, since the world is round, it might even return from the other side. Tomorrow is another day.
Andrew Jeffreys, Editor in Chief of Oxford Business Group, puts it as succinctly. “2015 is far off, and conditions may change,” he reminds. Hard to argue with that.

To peg or not to peg: that is the question

Calls to scrap the GCC’s fixed relationship with the dollar have to reckon with the alternatives.

May 1, 2006 | Gulf News | Andrew Shouler

https://gulfnews.com/business/sectors/features/to-peg-or-not-to-peg-that-is-the-question-1.235046

If you are invited to a presentation about corporate ethics hedging, it may take you a moment to grasp the concept. Since ‘ethical investment’ has become an established term, the phrase actually trips off the tongue. However, I’m glad to say it didn’t sound right when I heard it down the telephone. It suggested something implicitly like the route to an Enron-type result. Even if a company wanted to ‘hedge’ its ‘ethics’, would there be anyone proudly advertising such a service, let alone a well-known and reputable institution?

Better, of course, to hear clearly what you’re being told. Corporate FX hedging is the name of the game, and Standard Chartered Bank is talking that book. The much-awaited US dollar slide may be under way, and there is business to be had in offering protection against such foreign-exchange risk exposure.

That’s not the most interesting bit of the bank’s recent research report, however (in case you were wondering). It’s not even the second most interesting bit which, to me at least, was the forecast of the British pound falling even against a falling dollar over the course of the year. (The idea that the UAE dirham might still rise against sterling makes dollar-equivalent earnings less troubling to a British expat.)
And, on an infinitely bigger scale, that is the kind of issue which is the real story. It’s about not only risk, but real returns, to the Gulf countries as a whole.

Standard Chartered Bank recommends that the proposed GCC single currency should de-peg from the US dollar. It is not alone in that. The Dubai Chamber of Commerce and Industry implied as much in an economic bulletin a year ago, saying that floating would allow independent policy-making and avoid the same fate as the dollar.
The Gulf Research Center in Dubai has been discussing the issue on and off for some while.
Indeed, many have wondered aloud on this topic, while not all committing to a verdict. But the bank has repeated it, again, and argued a case.

Decision
If such a decision came, it would undoubtedly be a bold step, with significant implications. The currency itself may still be some way off, with occasional rumours that the 2010 deadline is in doubt. Yet, though timing is undoubtedly important (and especially so if the problem to be resolved is here and now), that’s actually not the key point.
Why, in fact, suggest such a radical step for a region whose currencies have mostly been pegged to the dollar for decades, which has not been especially troubled in doing so, and indeed now appears to be flourishing?

The bank’s reasoning, amid its carefully-defined research, boils down to two points, both easily accessible.

First, it is not in the best interests of the Gulf countries for their currencies to go down with the (apparently) sinking ship which is the dollar. While exports are mostly dollar-denominated, imports are substantially in other currencies, which would therefore become more expensive. That’s clear enough, leaving aside for the moment the incendiary topic of whether oil should continue to be priced in dollars.

Second, running domestic monetary policy in line with US policy (i.e., setting interest rates in parallel to the US Federal Reserve) always runs a risk, namely that the policy stance is inappropriate (too lax or too tight) for local conditions. The trade-off between the confidence generated by the fixed relationship on the one hand and policy inflexibility on the other is the core conundrum, and an increasingly live issue now, when interest rates seem considerably too low for the Gulf’s rampant economies.
They explain it further. The decline of the dollar against the euro through 2000-2004 increased the GCC’s import bill. The subsequent decline against Asian currencies too, projected to continue, represents a further “threat to the bottom line”. That currency mismatch applies also to budgets, where revenues are also mostly dollar-denominated, but spending frequently is not.
At the moment, whereas the dollar peg brings useful certainty vis-à-vis the dollar, with the hydrocarbon sector still so dominant it means that the impact of oil-price fluctuation is imparted fully to the real economy. Some form of currency float would allow the exchange rate (and interest rates) to take some of the strain.

Theme
Moreover, “Forex diversification is likely to become an increasingly important theme going forward” at the global level, so that having 90 per cent + of reserves in the dollar “is not necessarily appropriate any more”. A couple of diplomatic euphemisms there. In layman’s terms, if Asian central banks, Russia and others are going to flee the dollar, it may be better to be with them rather than trying to hold the fort.

“We believe the dollar is overvalued, and therefore could be subject to a significant correction,” says Standard Chartered. While that forecast appears cannily hedged itself, the warning is clear. The recommendation is that the planned GCC currency “should be marked against a trade-weighted basket instead”.

At one level, the logic is compelling. The idea that the Gulf region selling oil lucratively at $70 and in huge surplus should be tied to the dollar, with America in chronic deficit and buying expensively at the same price, does have a ring of absurdity about it. But is it as simple as that?

Stepping back, a barrage of advice has come over the years from the IMF (the same IMF which last week called for dollar devaluation). The outcome, however, has been inconclusive. While agreeing that a more flexible exchange rate policy may become desirable as the GCC economies become more diversified and integrated with world markets, it has generally found that a trade-weighted basket peg would be no better than a dollar peg in procuring stability, and the flexibility versus credibility debate becomes no clearer, though a euro/dollar combination may offer a reasonable alternative.

At the Gulf Research Center, economist Emilie Rutledge seems more convinced. As the “GCC’s economies are maturing and diversifying rapidly” the current inability to set their own monetary policy “is far from optimal”. Additionally, “as a longer-term investment the euro looks more promising than the dollar”.
She raises the further matter of the creation of a single GCC currency (the ‘Gulf dinar’) itself creating downward pressure on the dollar, as the oil-producing countries will invest more at home instead of (as previously) in dollar assets. The dinar may itself attain reserve status, especially if oil were priced in the same terms, though there would be “political disquiet” from the US in that event which is another understatement.
It should all give further pause for thought.
Wouldn’t the GCC states be prejudicing the value of their own existing reserves if they (effectively) acted against the dollar, whether by diversifying their assets, depegging, or pricing oil differently? In an environment of very high oil prices, could it actually be done without serious revaluation, which would jeopardise emerging non-oil activities and, ironically, call for (entirely inappropriate) lower interest rates? Not pegging risks the GCC tent being blown about by a potentially storm-force wind.
Standard Chartered Bank’s analysis suggests that flexibility will be manageable. The authorities could still offset current account inflows by capital outflows (though less into dollars), and would simply have to judge whether the exchange rate or interest rate were their priority.
So there it is. I’m not entirely convinced, but perfectly well accept that the GCC may have outgrown the peg. Meanwhile, it’s worth remembering that no exchange-rate regime on its own delivers a definitive economic framework. Fiscal control and structural matters remain beasts which have to be tamed for a successful, overall strategy.
Also, we are still talking about 2010. By my calculation, that’s getting on for four years away.
The dollar might still be ‘weak’ and the euro ‘strong’. We cannot know. But, won’t the markets have moved on a bit by then?
On the practical side, the European Central Bank is offering the GCC states advice, and their technocrats are probably among the least objectionable of the EU’s infrastructure. Whether the euro will appear in the policy mix is then an intriguing issue. Europe does not have much call for an even higher dollar exchange rate, but it does like gestures denoting prestige.

There’s another idea I could mention. If the GCC is on the lookout for another possible fix, like a ready-made US dollar & euro basket, it could consider a fairly heavyweight international currency which already fits that description. Despite the fact that it has been threatened with expiry, including by ministers and (almost hysterically) by so-called experts in its own country, it’s been around a very long time and it still works. It is far less volatile historically than either the dollar or the euro (see chart), because its balance of payments is relatively evenly exposed to both. You may even have heard of it. It’s called sterling: the British pound. Snag is: Standard Chartered do say it will fall faster than the dollar. Maybe. Anyway, it’s just a thought.

QUOTE
Hany Genena, Senior Economist, EFG-Hermes
Of course, de-pegging would imply appreciation of all GCC currencies. In 2005, the combined current account surplus of the six GCC states is estimated at approximately $160 billion, with net foreign assets in the banking system (excluding reserves accumulated in stabilisation funds) at approximately $260 to $300 billion.

With a positive outlook for crude oil prices over the medium term in addition to capital inflows, all GCC states will have significant appreciation pressures on their currencies. There is an important point to note here, though.

If the bulk of foreign currency inflows is channelled directly to central banks or stabilisation funds and re-invested abroad, then appreciation pressures could be mild.
De-pegging GCC currencies will not likely have a negative impact on the USD. Since GCC countries do not have enough investment opportunities domestically to absorb petrodollars, they will continue to find their ways into US Treasuries even after a revaluation.
In addition, unlike the case of China, currency revaluation in the GCC will not imply a decline in exports and a decline in accumulation of reserves, since crude oil exports are denominated in USD and are not sensitive to exchange rate movement. In fact, an appreciation of the GCC currencies could help resolve global imbalances by making US imports cheaper and reducing the deficit.

A shift in the demand for the USD by reallocating reserves, however, could indeed de-stabilise it. An outright exit from the USD by global central banks could indeed lead to its collapse. The cost of [the resulting] abrupt shock to interest rates in the US could be large. It could indeed lead to a global slowdown. I think that most GCC countries will opt towards a gradual shift in reserves.

Simon Williams, Senior Economist, Economist Intelligence Unit
De-pegging does make sense [for the GCCs], to run their own monetary policy. The inflationary situation at the moment throws that into very sharp relief. A lot of preparation would need to be done, including stopping pricing oil in dollars. Otherwise it risks compounding the volatility of the local currency value of oil revenues. The authorities would also have to guard very carefully against the kind of substantial appreciation pressures that there would undoubtedly be at the moment if the currency were floating.

Steve Brice, Regional Head of Research, Standard Chartered Bank
The key here is for the region to do what is best for the long-term sustainability of the region’s economic performance. We believe that authorities still have time to diversify reserves quietly before the new single currency comes into effect.
Forex reserves in fact are not the issue. The bigger issue is the investment agencies who are clearly large even in a global context. They would likely be discreet in their diversification efforts. However, the impact on the value of the dollar would be there for all to see.
[The interest-rate, exchange-rate trade-off] is a real challenge for the region, especially when taking into account the need to diversify the economies in order to create jobs for the hugely-expanding labour markets. In the short-term, this may create a conflict between managing the boom (higher interest rates) and help boost the diversification process (by ensuring a competitive currency). Clearly, the situation would need careful monitoring and managing.

On the issue of what currency to price oil in, we see no reason why an alternative currency/ies could not be used. If the GCC countries were to pursue a trade-weighted exchange rate target, then imagine the UAE, for instance, exporting to Europe. This would mean the importer would need to hedge its euro/dollar exposure and the UAE exporter would have to hedge its dollar/GCC exposure. Why not transact in either the GCC single currency or euro, which removes the need for one counterparty to hedge?

If [oil pricing] were in euro, the UAE would be able to naturally diversify its reserves away from a structurally weak dollar. Alternatively, it could price oil in dirham, and then make a rational investment decision as to what to do with that money.

Pierre Cailleteau, Senior VP, Sovereign Risk Unit, Moody’s
We do not make recommendations, but I am not entirely sure whether a change of policy would help fix the problem. I don’t really see an alternative regime that would be superior. If you have a flexible exchange rate, and it rises with capital inflows which create higher credit and inflation, then interest rates are raised, then the exchange rate rises again ? [It is a vicious circle.]

Practically, it may be better to endure the peg. It is the price paid for a less-than-perfect policy regime [like any]. Any country with high commodity dependence has this issue. In the case of Norway or Canada, the ratio is lower than here. The UAE [and GCC] are a special case, with a huge exchange-rate ‘overshoot’ and ‘undershoot’ possibility. In any case, it is unwise to shift from a fixed system to flexible without the rest of the policy framework and banking system being ready. Change could mean GDP would become even more volatile.

Gulf countries shifting funds to emerging markets

GCC countries are realigning their investment plans and ploughing their oil wealth in emerging markets instead of the western developed countries, says the latest report from a regional research body.

April 16, 2006 | Gulf News | Stanley Carvalho

https://gulfnews.com/business/sectors/markets/gulf-countries-shifting-funds-to-emerging-markets-1.233112

GCC countries are realigning their investment plans and ploughing their oil wealth in emerging markets instead of the western developed countries, says the latest report from a regional research body.

“The DP World debacle witnessed in America and currently unfolding in India should not and most probably will not deter the GCC’s foreign investment plans, but may herald realignment,” says Emilie Rutledge, economic researcher at the Dubai-based Gulf Research Centre (GRC).

“There is little doubt that the anti-Arab sentiment experienced by DP World will, to a certain extent, deter other GCC investors from seeking to acquire US assets. But more generally, Gulf governments are no longer happy to simply hold US Treasury bonds. Today, they are more interested in the return on their investments, and are more willing to take calculated risks and invest in key Asian growth markets such as China and India.”

For example, the Kuwait Investment Authority (KIA) is currently in the process of realigning investment in Organisation for Economic Cooperation and Development countries to emerging markets, noted the report, quoting Bader Al Sa’ad, KIA’s managing director.
The Gulf states plan to invest more revenues from oil sales in Asian countries to strengthen ties with their fastest-growing energy customers.

The Abu Dhabi Investment Authority (ADIA) and KIA is in the process of buying 10 per cent of the Industrial and Commercial Bank of China for a reported $2 billion. ADIA, one of the world’s richest investment bodies, is known to be looking to buy more assets in emerging markets, such as Chinese insurance and oil and gas companies as well as Indian financial services firms.

Dubai’s Istithmar is refreshingly open with regard to its strategies and acquisitions and has acquired a significant shareholding in SpiceJet, a leading low-cost airline in India, which was launched in May 2005. But despite some recent setbacks like the DP World case, the report suggests that the GCC countries should focus on acquiring assets abroad.

“GCC governments can and should do several things with current windfall revenues and surplus liquidity in order to mitigate the risks of future oil price shocks. The period of protracted economic stagnation suffered by the region for much of the 1980s and 1990s must not be forgotten. Apart from investing in infrastructure and human capital and moving into the value-added downstream energy industries, the GCC should concentrate on acquiring overseas assets.”