GCC can still back single currency

(IMAD ALAEDDINN)   

Earlier this week, Oman formally announced it was abandoning its involvement in the proposed Gulf monetary union, which will officially be launched in 2010.

Oman’s decision has increased speculation the project may never become reality, but Khaled Alloush, United Nations Development Programme resident co-ordinator for the UAE, insists a single currency is key to the long-term prosperity of the region.

“The GCC (Gulf Co-operation Council) should get together and move quickly into monetary union,” said Alloush. “GCC members will never be able to establish full monetary independence alone, but together they can because the combined size of the economy is becoming very significant and will soon top $1 trillion (Dh3.67trn).”

Alloush would not be drawn on whether a single Gulf currency should be free floating or linked to a basket of currencies. In 2004, the GCC states agreed to adopt the five official convergence criteria used by the European Union before the launch of the euro.

The member countries have met four of these requirements concerning budget debt, public debt long-term interest rates and foreign reserves. However, they fall spectacularly short of passing the inflation benchmark, which states that a member’s inflation rates must not be more than two per cent above the average of the lowest three.

Using official 2006 figures, the average of the lowest three GCC members was 2.43, yet UAE and Qatar inflation was 9.3 and 11.8 per cent respectively.  “The inflation is only one aspect of the convergence criteria,” said Gene Leon, assistant to the director of the International Monetary Fund’s Middle East and Central Asia Department.

“At the last meeting of [GCC] heads of state in December, they had an understanding that different countries could follow separate policies to tackle inflation. The disparity in inflation rates is a concern from a monetary union perspective, although the convergence criteria are not binding. GCC members are part of the Union regardless. In the EU it was different – you had to pass the test to join the club.”

Leon refused to deviate from the official line, saying the wide divergence in UAE inflation rates would not force the GCC to delay proposed currency union, despite few commentators outside the respective governments believing this will be possible within the 2010 deadline. “I don’t think currency union will happen in 2010,” said Eckart Woertz, economics programme manager at Gulf Research Centre.

“Widely divergent inflation rates are one factor, but there’s also administrative hurdles to overcome such as printing the money and educating companies and consumers, as well as deciding whether to have a central bank and where it would be located.”

As a prelude to monetary union, the GCC launched a customs union in 2003 to allow free movement of goods and services. This was followed in January with the establishment of a Gulf common market to allow unrestricted movement of capital and labour. However, the latter applies only to nationals.

Woertz added: “Currency union is over debated. Without a functioning customs union and common market, a single currency is not very relevant.” Last year, the GCC accounted for 1.5 per cent of global gross domestic product and 3.3 per cent of worldwide exports.

As relatively small players in the world economy, the Gulf states have found it beneficial to fix their currencies to the US dollar, with the UAE peg unchanged since 1997, while Bahrain, Saudi Arabia, Qatar and Oman have not changed their currency regime since 1986.

Kuwait, however, switched to a basket of currencies in a surprise move in May 2007. With the dollar depreciating by more than a third against the euro over the past five years, the UN’s Alloush echoed the views of many regional economists who question the wisdom of the respective currency pegs when this means monetary policy and, most importantly, interest rates are effectively set in Washington.

The US Federal Reserve has reduced its interest rates from 5.25 per cent to three per cent since September last year, with the UAE Central Bank forced to follow suit, despite such a move only adding to the deepening inflationary woes.

Official UAE inflation in 2006 was 9.3 per cent, while the 2007 figure is expected to be slightly lower. In normal circumstances, central banks would be raising interest rates to mop up liquidity and rein in money supply to keep a lid on inflation, yet the UAE has done the opposite.

Alloush said: “If GCC currencies were allowed to appreciate, it would make the region’s exports less competitive, but in reality the large bulk of export revenues come from oil, which is denominated in dollars so it would not make any difference. “If the dollar continues to depreciate, the GCC will be forced to address the issue sooner or later.”

Oil revenues would decline relative to the revalued local currencies, which would reduce state spending power.