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Europe’s most grandiose dream – achieving economic and monetary union across its members – almost came apart this spring. Although the eurozone has since pulled back from the brink, with fears of a sovereign default having abated for now, ripples from the region’s debt crisis have washed ashore to the other major trading blocs in Latin America, Asia and the Middle East undertaking similar projects. The crisis came at an inauspicious time for four members of the Gulf Cooperation Council – Saudi Arabia, Kuwait, Bahrain and Qatar – which by this March had finally set up the Gulf Monetary Council, a likely progenitor of a unified central bank. The other two members of the GCC pulled out of the project earlier (Oman in 2006 and the United Arab States last year after a decision to base the central bank in Saudi Arabia).
The long shadow of the eurozone debacle and its broken policy framework is worrying analysts in the Gulf. According to Paul Gamble, head of research at Jadwa Investment in Riyadh, the crisis in Europe must inevitably impinge on GCC strategy. “The ECB [European Central Bank] model has a big impact on the GCC. The Maastricht convergence criteria were used by the GCC – even though they were devised specifically around conditions in EU economies, and there has been considerable ECB technical assistance.”
POLITICAL WILL
Gamble says GCC policy-makers have become more sceptical, raising questions about the suitability of a GCC single currency. “It highlights the political will a project of such magnitude needs to function. This political will seems to be lacking in the GCC at present.”
The requisite strength of will required is not lost on policy-makers. Rasheed Al Maraj, governor of the Central Bank of Bahrain (CBB), says: “We need a monetary union that will support the maturing process of our economies. For this to be achieved, the right structure and rules must be clearly in place from the outset, and all of the members must take equal responsibility for its success.”
As head of the newly enacted monetary council, Muhammad Al Jasser, governor of the Saudi Arabian Monetary Agency, the central bank, is no doubt pondering events in Europe. He is acutely aware that political will can simultaneously be interpreted as political dominance in the sensitive Gulf.
Last year’s decision by the UAE to walk away from the prospect of creating a unified $1 trillion economic bloc – with all its attendant economic benefits – highlights just how fractious feelings can get. Jasser and his team are grappling with the fact that many consider the exit of the UAE a mortal blow but must also consider whether the fallout in Europe questions the efficacy of the project.
The UAE’s withdrawal further undermines the already weak argument that intra-regional trade is boosted by the pact, says Mohamed Jaber, vice-president of Morgan Stanley in Dubai. “Less than 5% of Saudi Arabia’s and the UAE’s total imports come from the GCC.”
However, the UAE’s decision does not diminish the overall viability of monetary union, says Paul Reynolds, managing director of Rothschilds Middle East, who points to the UK’s separate but proximate relationship with the EU. “In the eurozone, non-membership does not prevent the UK from playing a leadership role,” he says.
However, Reynolds acknowledges the constraint the UAE’s absence imposes. “Gulf monetary union is unlikely to fulfil its greatest potential while a major trading counterparty is not within the bloc.”
Perhaps the EU’s biggest failing was its inability to agree on cross-border fiscal transfers requiring member states to transfer tax revenues and government duties to a central federal entity. Experts say it seems impossibly ambitious for the GCC to agree to such a policy, and the lack of an agreement may dent confidence in the future single currency.
For all that, the road to Gulf monetary union seems paved with good intentions. “Europe illustrated that we need clearer central policies for addressing issues and taking swift action when issues arise. We do not intend to copy an existing monetary union but one that is adapted to our specific needs and circumstances,” says Rasheed Al Maraj of CBB.
Sheikh Mohammed bin Essa Al Khalifa, chief executive of the Economic Development Board in Bahrain, says there are also fundamental differences between the two regions. “GCC economies are much more similar than those of the EU. We remain closely aligned due to our links to oil, and we have similar economic cycles.
“The lesson learned from the EU is the importance of fiscal coordination and is something we need to look at, and whether it is possible to link fiscal policies to sustained monetary policies.”
DOLLAR PEGS
With the exception of Kuwait, all GCC currencies are pegged to the US dollar, largely because of the region’s hydrocarbon revenues. (In Kuwait the dinar is pegged to a basket of currencies but one that is essentially dollar based.)
Philippe Dauba-Pantanacce, senior economist for Middle East and North Africa at Standard Chartered Bank in Dubai, thinks problems in Europe are a distraction and irrelevant to GCC monetary union. “I don’t think that the two are comparable, and the end aim of monetary union is certainly different.”
However, he says the commitment required suggests the experience in Europe is one that the GCC cannot ignore lightly. “There needs to be a common legal framework, payment system infrastructures and adoption of market standards like Target (Trans European Real Time Gross Settlement Express Transfer) in Europe.”
Essentially the GCC already has a de facto single currency – the US dollar. It is the GCC’s dollar peg, which could ease the path to monetary union avoiding the integration problems experienced by Europe in the run-up to the launch of the euro.
Yet, not all agree a continued peg to the dollar is a good thing for the region. One of the most influential voices is that of Robert Shiller, a professor of economics at Yale University. “Pegging to a currency on the other side of the world entails risks. It may not be the right exchange rate, and the cost is a misalignment of exchange rates. Probably any country that has confidence in its monetary institutions should not peg to the dollar.”
That argument is also bolstered by bilateral trade data. According to a report by NCB Capital in Saudi Arabia, only 9.7% of GCC trade is conducted with the US, which considerably increases the argument for the GCC to move to a currency basket that includes appropriate exposure to the euro and other currencies.
If that is the case, the GCC faces a formidable challenge of integration.
Dauba-Pantanacce says the GCC should implement a two-stage solution: “The best way is gradual institution building that would lead to monetary union, possibly pegged to the dollar for a transition period, and then shift to a currency basket that represents the trading partners of this region.”
The secretary-general of the GCC, Abdulrahman Al Attiyah, suggests the way forward starts with a monetary authority – and from there moves on to more integrated complex economic and monetary union objectives.
TRANSPARENCY DILEMMA
One of the other most visible outcomes arising from Europe’s debt crisis is standards of governance and transparency. The emphasis is clearly now on increased regulation but, by and large, the GCC does not do transparency – much to the chagrin of international investors.
The dispute between two major companies in Saudi Arabia that borrowed $22 billion principally on the basis of their name has catapulted the regional debate on governance to the fore. It is an important issue because the systemic impact on the banking system is difficult to gauge in the opaque Gulf environment.
Europe’s experience may necessitate better disclosure – particularly if the Gulf Monetary Council adopts a trade weighted currency basket. A future GCC currency could be susceptible to speculation if doubts over the transparency of government institutions persist in international financial markets.
What is clear is the extent to which Europe has become polarized. Germany is clearly fiscally incompatible with its southern neighbours, and this showed itself in recent political tensions. The GCC looks unlikely to suffer the same fate – it is financially, culturally and philosophically more cohesive.
All the GCC economies are net capital exporters with a positive balance of trade and government surpluses.
The next big test for the Gulf is likely to be in 2012 according to Ben Simpfendorfer, chief economist at RBS in Hong Kong. “The euro will have sorted through many of its problems while attention may shift back to the US fiscal deficit. If the dollar were to weaken again, then worries about the Gulf’s foreign exchange policies may return.”
The travails of the euro and its spill-over to GCC policy-making highlight the distance that has to be travelled in moving economic and monetary union on further. “I don’t think there will be a regional single currency,” says Gamble at Jadwa Investment.
That debate may be influenced or decided by the price of oil and the unstable geopolitical environment. In the EU the single currency was perceived as a precursor to greater federal political integration. Whether the Gulf is ready for that – or indeed capable – has yet to be determined.