GCC joint currency may initially keep dollar link
GCC Secretary-General Abdul Rahman Al Attiyah has not specified the type and form the GCC joint currency will take but analysts believe it could initially be linked to the US dollar. "My feeling is that the GCC currency will be pegged to the US dollar in the first stage of the union as it is the official price of oil exports, which account for the bulk of their exports. A large part of their foreign assets is also denominated in dollars," said Mohammed Al Asumi, a Gulf-based economist.
"A basket of currencies in the union's early stages would raise several technical difficulties in their currency and fiscal policy alignment. A basket of currencies could be chosen later but the dollar will have at least a 60 per cent share of its components," he said.
This view is echoed by the Saudi American Bank Group (Samba), which said the four members – Saudi Arabia, Kuwait, Qatar and Bahrain – would likely keep that peg. "The dollar peg may continue to be the preferred exchange rate regime for the bloc in the foreseeable future," Samba said.
"In particular, interest rate transmission signals are weak in the GCC, given the preponderance of actual and expected government spending on consumption and investment decisions. If changes to nominal interest rates have little impact on spending patterns of firms and households, then much of the advantage associated with a floating exchange rate is lost."
But it noted that this could change over a longer period, as regional financial and capital markets broaden and deepen, thereby enhancing potential advantages of a more flexible exchange rate at a later stage. "A flexible exchange rate would help encourage a more robust, diversified and competitive non-oil export sector, which in turn could spur on sustainable employment growth," the study said.
Samba also said: "The main disadvantage is that the monetary policy must move in step with the US. Over the long term, there has been growing convergence between GCC and US business cycles, meaning the US monetary policy has been appropriate for the GCC. However, recent years have seen a sharp divergence: Between 2006 and H1 of 2008, the US economy slowed sharply while GCC export earnings and domestic demand continued to surge. The peg meant that GCC authorities were obliged to reduce interest rates at a time when raising them would have been more helpful. In such circumstances, GCC authorities must rely on fiscal restraint (and to a lesser extent tighter prudential regulations) to manage domestic demand. The peg also means the GCC cannot defend against imported inflation by letting the nominal exchange rate appreciate," it said.
Samba noted that advocates of the proposed managed float argue this would allow countries to absorb major shocks more easily than a fixed exchange rate regime. "Beyond this, an autonomous monetary policy would allow appropriate monetary responses to domestic demand conditions. Thus, if demand was in danger of overheating, nominal interest rates could be adjusted accordingly. The credibility of the float would be underpinned by the GCC's vast stock of foreign assets," the report said.
Samba said a peg to the price of oil could be an alternative as it delivers automatic accommodation to terms of trade shocks, while retaining credibility-enhancing advantages of a nominal anchor. "Its proponents argue this would allow the real exchange rate to achieve equilibrium and decouple oil exporters' monetary policies from those of oil importers. Its detractors say the price of oil is not truly exogenous, since oil production policies of the GCC states themselves influence the price. The volatility of oil prices would also present problems, forcing potentially sharp day-to-day swings in the exchange rate, making planning difficult," the report said.
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