By Jon Marks and Eleanor Gillespie
GCC economies may have emerged as giants on the global stage, but plans for currency union are in disarray
So flush with cash are the six Gulf Cooperation Council (GCC) economies that they make most investment managers giddy with enthusiasm. Their mighty sovereign funds stalk the earth in search of targets, making players like Qatar Investment Agency and Dubai World as familiar to private equity analysts as stalwart investors like US Carlyle Group – in which Abu Dhabi recently took a stake.
But closer to home, the GCC six – Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates – are mired in problems getting their own currency union off the ground.
Kuwait’s decision in May to abandon the dollar peg to which all GCC members were until then committed was seen as a major setback for the planned single currency. Oman had already said that it could not meet the single currency’s agreed 2010 launch date, while UAE central bank governor Sultan Bin Nasser al-Suwaidi – who in previous conversations with Emerging Markets had come over as a single currency bull – suggested that ambitions could be scaled back to a more limited common monetary policy.
Saudi Arabia Monetary Agency (SAMA) governor Hamad Al-Sayari added to the speculation, saying that Gulf finance ministers and central bank governors would meet in October to discuss the single currency plan. This could help to redefine policy ahead of what could be one of the most important GCC summits for years, to be held in Doha, Qatar, in December.
Analysts in the region are watching like hawks to see how Saudi Arabia, the lynchpin for any Gulf monetary policy, acts. A late September decision by SAMA not to follow the US Federal Reserve in its rate cuts led to speculation that even Riyadh might be considering cutting the dollar peg.
SAMA said the move was intended to counter inflationary tendencies. The riyal has been pegged to the greenback at $1=SR3.75 since December 1986. Usually in the kingdom there is little public fact to work on when big political and economic decisions are made, but this time King Abdullah bin Abdulaziz al-Saud’s adviser Ihsan Bu-Hulaiga went on the record to say it was “not necessary that there will be a de-pegging of the riyal from the dollar” – at least “not in the near future”.
A sign of the times: hedge funds started buying the riyal – over $100 billion-worth of the Saudi currency in the last week of September – just as they did in the quarter before Kuwait set the cat among the pigeons by revaluing. This interest pushed Saudi forward riyal contracts to a 21-year high on September 24, at $1=SR3.7352, before slipping back to SR.3.4715 by end-month.
Highly conservative Gulf bankers do not like to see this sort of activity, but these developments show the markets have perceived that Gulf currencies are in play and profits can be made, as governments deviate from the path previously laid out for GCC currency union.
When Emerging Markets asked Saudi finance minister Al-Assaf directly about the fate of the riyal peg, however, he sought to curb that perception with an unwavering stance. “The riyal’s exchange regime has served, and continues to serve, the economy so well and there is no need for any change at this time. We have repeatedly expressed our views of no intention to change the parity. This view remains strongly valid.”
The summit really matters
With the 2010 deadline for the planned union having seemingly receded over the horizon – and even without the need to coordinate on such regional preoccupations as the prospects for communal meltdown in Iraq and a global conflict with Iran – this December’s annual GCC summit assumes greater than usual importance. Originally scheduled for Muscat, Oman, the venue was moved to Doha, Qatar, following last June’s Indian Ocean cyclone Gonu.
While Oman has long balanced its strong pro-western strategic orientation with an ability to get on with all its neighbours, making laid-back Muscat an ideal venue for tough talking behind closed doors, Qatar under Emir Sheikh Hamad bin Khalifa al-Thani and his prime minister and foreign minister Sheikh Hamad bin Jassim bin Jabr al-Thani has developed a thornier relationship with its GCC partners. Hamad bin Jassim is the driving force behind Al-Jazeera Satellite Channel, which has been upsetting the Saudi royals since its foundation in 1996; Riyadh recalled its ambassador to Doha in September 2002 following a public dispute over Al-Jazeera.
Such is the summit’s importance that Qatar and its giant neighbour have decided to enact a reconciliation, according to one diplomat in the region. Emir Sheikh Hamad and Hamad bin Jassim led a delegation to Jeddah in late September for talks with King Abdullah, which included Al-Jazeera chairman Sheikh Hamad bin Thamer al-Thani. An official subsequently said Qatar had agreed “to stop Al-Jazeera from undermining the kingdom”.
Kuwait blinked first
There is a clear need to put the monetary union plan back on track – or to hammer out a new policy to replace it. Kuwait’s decision to de-peg was important, says Standard & Poor’s chief sovereign risk analyst for the Middle East, Farouk Soussa, because “it will affect the prospects for development of a Gulf single currency”. The decision had “‘symbolic and political importance’ [as] it highlights the reluctance of Gulf governments to accept the need to pool a measure of sovereignty, to accept that they are bound by a common agreed policy, if they are to establish a credible monetary union and single currency.”
A new arrangement would have to be based on currency baskets whose detailed content would then have to be harmonized; GCC members need to negotiate a new convergence programme.
Kuwait – usually seen as a GCC enthusiast – abandoned the common regional monetary stance, citing national interests. Tying the dinar’s value to a diversified basket – including the euro, sterling and Asian currencies – was essential, Kuwaiti officials told Emerging Markets, to stop the dollar “dragging” down the Kuwaiti dinar’s value. The dollar link had forced up the cost of imports and doubled the inflation rate; Kuwait had already revalued in 2005 and 2006, and the dinar had been floating at the top of its 3.5% fluctuation band. A further revaluation was expected this year, had Kuwait not dropped the peg altogether.
Inflation is a big worry in some Gulf states – notably those with red hot property markets, like the UAE, Qatar and Bahrain – but all these have said they remain committed to the dollar.
Economic factors alone may not fully explain the Kuwaiti move, a prominent MP told Emerging Markets: “We saw other Gulf countries lacked the political will to take the common steps required to move towards a viable single currency.” This view was shared by a senior Kuwaiti economic adviser, who told Emerging Markets that “unfortunately, the economic boom in the region will slow down economic integration – each country is busy with its own boom, and they don’t see the benefit of economic integration.”
Reasons to stay in
Shortly before the hedge funds started piling into a riyal they saw was out of sync with the dollar, the Institute of International Finance (IIF) produced a report, which noted that, while a “more flexible exchange rate would allow SAMA to reclaim control of interest rates”, the authorities were “likely to resist calls for a revaluation or a dismantling of the peg for a number of reasons”. According to SAMA, the weakening riyal is not the major cause for domestic inflation. And a stronger local currency would add to the cost of entry for foreign investors, just as Saudi Arabia is seeking to attract more money from overseas for its “industrial cities” project.
From a financial perspective, Saudi British Bank’s chief economist John Sfakianakis argues that it is also “highly unlikely that Saudi Arabia and the rest of the GCC will make any moves away from the dollar” while oil continues to be traded in dollars – this would cut the value of Gulf oil revenues in local currency terms, as well as creating a currency mismatch for the central banks.
Strategic relationships
Then there is the political angle. In moves to keep Gulf states firmly in the US camp, Central Command (Centcom) and key Bush administration players have developed a new Gulf Security Dialogue (GSD) initiative to promote mutual interests across the GCC, observes Olive Security’s research director Michael Knights. “The dialogue’s offer of access to senior US decision-makers may be as important as the content of GSD discussions,” says Knights, a Gulf security specialist: “With the exception of Saudi Arabia, GCC states have felt starved of a stable US government interlocutor for years, with key military figures rotating and Bush administration Middle East staff falling like ninepins.” In view of the refreshed US relationship, Gulf states would want to consult carefully before taking a decision that could precipitate an even faster decline in the US dollar, with destabilizing economic effects on both sides.
Relationships within the GCC remain at least equally important, and Al-Assaf for one is not prepared to abandon the goal of GCC economic and monetary union just yet. “The benefits include, but are not limited to, harmonizing economic policies, reducing transactions costs, and leveling the playing field for domestic, regional, and foreign investments. These benefits remain as relevant today as they have been before,” he says.
But he acknowledges that “some members may not be in a position to join the union at its inception.” Al-Assaf says all GCC governments are ready to be flexible on the concept of later entry for some members. He hopes that a joint meeting of the group’s finance ministers and central bank governors following the IMF annual meetings will be able to set out a new timetable for the whole process, potentially “further down the road”.