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29 March 2024

Dollar right option before GCC currency union

Combined nominal GDP of six GCC members could reach around $999bn in 2010. (SUPPLIED)

Published
By Nadim Kawach

The US dollar will remain the right option for Gulf oil producers as a peg to their currencies before they enforce their historic monetary union but they can consider other options afterwards, a key Western financial centre has said.

Despite the recent weakening in the dollar, resurrecting inflation fears in 2008, forward currency movements do not indicate there is any plan by the six Gulf Cooperation Council (GCC) nations to end the peg, the Washington-based Institute of International Finance (IIF) said in its latest quarterly report.

“There is no pressure on the peg to the dollar in all countries of the GCC, and it is expected to be maintained at least until the monetary union. Forward rates point to no change for local currencies despite the recent weakness of the dollar,” said the study, sent to 'Emirates 24|7' this week. “We share the view that the peg is still the right exchange rate, at least until the GCC economies achieve monetary union when they can revisit their options.”

IIF said it believed the peg is easy to administer and does not require the necessary institutions for implementing an independent monetary policy.
 
It said such institutions would need first to be created, become effective, and establish credibility. “The dollar peg provides a credible and easily understood anchor for monetary policy,” it added.

GCC currencies, except the Kuwaiti dinar, have remained effectively attached to the US dollar for nearly three decades despite the sharp fluctuations in its rate.

Kuwait dropped the peg three years ago in a bid to tackle rising inflation as the dollar’s slackening rate was cited as a key factor for soaring domestic prices.

Speculation heightened during 2007-2008 that GCC nations could appreciate their currencies against the dollar to tackle inflation, triggering a massive influx of hot money into the region. But most of the funds pulled out in the wake of the 2008 global fiscal crisis and GCC statements that there are no depegging plans.

Gulf countries have not made clear what currency they would adopt when they enforce their monetary union, which was announced early this year by four members - Saudi Arabia, Kuwait, Qatar and Bahrain. The UAE, the second largest Arab economy, and Oman have quit the project.

“The introduction of a common currency is also likely to enhance growth prospects by contributing to the unification and development of the region’s  bond and equity markets and by improving the efficiency of financial services.

A GCC monetary union would possess strong elements of cohesion because of the strong fundamentals of the GCC economies,” IIF said. “A GCC monetary union, especially if supported by the requisite policy and institutional infrastructure, would boost the GCC’s political and economic leverage in the region, promote policy coordination, reduce transactions costs, and boost trade and investments within the region.”

According to IIF, the GCC countries are considered the most homogenous group among the existing monetary unions in the world, including two in Africa, one in the Caribbean, and one in Europe.

It noted that the GCC nations share a common history, language, culture, economic structure, and similar levels of economic and social development.  “The establishment of a monetary union over the medium term therefore carries minimal risks while such a union would create an important regional entity with a population of around 40 million and an estimated combined GDP of close to $1 trillion (Dh3.67trn),” the report said, assuming a six-nation monetary union.

Its figures showed the combined nominal gross domestic product of the six members could reach around $999 billion in 2010, including nearly $440bn  for Saudi Arabia and $241bn for the UAE. It estimated GDP at $125bn in Kuwait, $117bn in Qatar, $54bn in Oman and $23bn in Bahrain.