Gulf monetary union to peg new currency against the dollar initially

Four Gulf oil producers seeking to create the Middle East's first monetary union will likely peg their currencies to the US dollar in the first stages of the project before deciding on a final common currency, a Saudi bank said yesterday.

Saudi Arabia, Kuwait, Qatar and Bahrain – four members of the six-nation Gulf Cooperation Council (GCC) – could also face challenges in launching the project on time in 2010 but it could be created in phases, the Saudi American Bank Group (Samba) said in its latest economic bulletin.

The report noted that the newly formed Monetary Council would assume the responsibilities of coordinating monetary policy, drafting the charter of the GCC central bank, and oversee the technical committees work and the design of the new currency for the world's second monetary union.

"The January 2010 target for a single currency is challenging, and more time will probably be needed to finalise the operational framework of the central bank, harmonise statistics, and improve regional payment systems," Samba said in its 10-page bulletin.

"However, we do not view this as a matter of concern: GCC currency union should be seen as evolutionary process rather than an abrupt break with the past. In the meantime, we do not expect any changes to GCC exchange rate regimes, including in those countries currently opted out of monetary union.

In the first instance, we also expect that the single currency will retain the dollar peg."

The UAE and Oman have pulled out of the monetary union but officials from both countries have hinted the doors remain open for them to rejoin in the future.

The signatories for the union have already sought help from the International Monetary Fund (IMF) regarding the form of the new currency. The IMF proposals included an initial dollar peg and a small appreciation of the Gulf currencies.

In another study last month, the Washington-based IMF said the four GCC nations need to adopt a flexible exchange rate for their common currency when they launch the landmark union in stages early next year.

The Fund, in its annual review of the Saudi economy, said the long-standing peg between the Saudi riyal and the US dollar had ensured economic and financial stability to the world's largest oil exporter.

IMF Directors said the decline in the riyal in 2008 because of the weakening in the dollar was only temporary and could recover in the medium term.

"Some directors encouraged the authorities to consider a more flexible exchange rate regime for the GCC monetary union, in consultation with other members of the union," the report said.

"Directors encouraged progress toward the monetary union by developing operational responsibilities and the governance structure of the future central bank, harmonising macroeconomic statistics, and establishing an efficient payments system."

The four members of the proposed union have indicated their currencies would remain pegged to the dollar in the initial stages but they would decide on a new peg at a later stage. Some officials have spoken of a basket of currencies in which the US dollar would have a lions share.

"Following a brief period of stress in late 2008 when spreads on GCC forward exchange rates were pricing in large implicit devaluations, pressure on GCC currency pegs to the US dollar has since abated in line with successful government interventions to restore liquidity, and the recovery in oil prices," Samba said.

"In addition, inflation in the GCC is falling sharply, and US and GCC business cycles and monetary policy needs have now converged, reducing some of the recent costs associated with maintaining the peg (during 2007 and the first half of 2008 GCC central banks were compelled to lower interest rates in line with the US despite their then overheating economies and soaring inflation)."

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