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25 April 2024

Fall in UAE and Qatar inflation will remove key hurdle for creation of monetary union

By Nadim Kawach
An expected decline in inflation in the UAE and Qatar within the next year will remove a main stumbling block for the creation in the Gulf of the world's second monetary union, experts said yesterday.

But they acknowledged high inflation in those two countries and a widening gap in the level of the consumer price index with the six-nation Gulf Co-operation Council (GCC) have been the biggest hurdle for the currency union in the 28-year-old Gulf economic, defence and political alliance.

"High inflation in some member states is a big problem and has been one of the key obstacles for the creation of the GCC currency union," said Mohammed Al Asumi, a Gulf economist.

"But I believe this obstacle will disappear because there are expectations that inflation in Qatar and the UAE will drop at the end of this year or in 2010. This decline will bridge the big gap in inflation rates within the GCC and consequently support efforts to launch the monetary union on time."

At their annual summit just before the end of the year, GCC leaders gave the green light for launching of the monetary union despite Oman's decision not to join the project on the grounds that it is not ready yet.

They had set 2010 as an initial deadline for starting the scheme but many experts and institutions doubt the ambitious plan would materialise on time.

"Inflation has been and is still the biggest obstacle and challenge facing the GCC countries in establishing the proposed monetary union," said Saleh Al Sultan, a former economic advisor at the Saudi Ministry of Finance.

"Inflation driven by local factors is linked to monetary and fiscal policies, which means GCC countries must create a suitable governance framework to ensure compliance with policies governing inflation, and this framework could materialise by the creation of a GCC monetary authority and a Gulf Central Bank. To tackle the gap in inflation, the GCC needs to upgrade transparency and the issuance and exchange of data."

Quoted by Saudi newspapers yesterday, Al Sultan said the big gap in inflation within the GCC has been created by surge in public spending by some member states, mainly the UAE and Qatar, as a result of massive financial surpluses generated by a sharp rise in their oil income over the past four years.

"Those who are overseeing the creation of the GCC monetary union are supposed to tackle the problem of high public spending and its effects on inflation in some members, and consequently on the monetary union," he said.

Asumi said the launch of the union hinges on the completion of the remaining technical matters by the monetary council.

"It also depends on whether each member is prepared in terms of adjustment of its laws and policies. There are also such vital issues as the creation of the Gulf central bank and the single currency," he said.

"The union could be launched gradually on time but it could also be delayed pending the completion of all technical matters, it could be launched if at least four members announce they are ready to join the union."

In a study last month, a prominent Western financial centre said it expected the GCC currency union to be delayed because of high inflation rates in some member states and the need for more fiscal adjustments.

"Some progress has been made toward the monetary union. The charter for a monetary council, a precursor to a regional central bank was approved in September 2008 by central bank governors, nevertheless, achievement of the target date of 2010 for the monetary union is unlikely given the remaining challenges," the US-based Institute for International Finance (IIF) said.

"These challenges include an agreement on the nature and scope of the GCC monetary authority and the introduction of a common currency, harmonisation of key regulatory and supervisory frameworks, especially for the financial sector, and statistical methodologies for key financial and economic indicators; and agreement on the customs union and the issues outstanding with regard to the sharing of customs revenue."

The study said inflation needs to be reduced since the inflation convergence is now taking place at double-digit figures rather than at low levels. IIF also underlined the need for what it described as the "harmonisation" of the statistical base in member states in order to provide comparable economic and financial data.

According to IIF and other institutions, inflation in the GCC will start to decline in 2009 due to a drop in global prices and relative strengthening of the US dollar, to which most GCC currencies are pegged.

Stifled liquidity and an expected shelving of some projects could also drive inflation down.

Inflation peaked at 7.2 per cent in the GCC in 2007 and was expected to have swelled further to around 9.5 per cent in 2008. Qatar and the UAE recorded the highest inflation rates of 13.8 and 11.1 per cent in 2007 and were expected to maintain high rates of 14 and 14 per cent in 2008.

Despite Oman's decision to pull out, the five other members – the UAE, Kuwait, Saudi Arabia, Qatar and Bahrain – have reported progress in negotiations on the plan, including fiscal convergence, the creation of a monetary council and a central bank, which the UAE has offered to host.

Requirements for convergence

- Inflation should not be higher than two percentage points above the average rate of the six states

- Interest rates should not be higher than two percentage points above the average of the lowest three countries' rates

- Foreign exchange reserves in excess of the equivalent of four months of imports

- Budget deficit lower than three per cent of GDP, or five per cent if oil prices are low.

- Public debt-to-GDP lower than 60 per cent