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Emerging Markets

Uncommon currency

A realization that a Gulf monetary union without the UAE makes little sense may well trigger renewed efforts to bring the state back into the fold

The best-laid plans of mice and men often go astray, wrote the poet Robert Burns. For the six Gulf Cooperation Council (GCC) states that have been planning a single currency for the best part of a decade, that theme seems particularly applicable.

On May 20, the United Arab Emirates (UAE) announced it was pulling out of the monetary union process, in protest at the decision to locate the GCC Monetary Council, the proposed forerunner of a GCC central bank, in Riyadh rather than the UAE capital Abu Dhabi.

Having already lost Oman, which withdrew from the plans for monetary union in 2006, Abu Dhabi’s decision came as a body blow to the GCC’s ambition to forge a common currency. While Oman’s retreat could be absorbed, the opting out of the GCC’s second-largest economy and main regional trading hub, appeared as a nail in the coffin.



DILEMMA

The four members still committed to monetary union have a dilemma on their hands: either to continue with a smaller Gulfzone currency area that excludes Oman and the UAE, or to rethink the entire process. The latter could mean either scrapping the project – an unlikely prospect given the importance imbued in it – or embarking on a renewed attempt to bring the two recalcitrant members back into the fold.

“Either Abu Dhabi will be encouraged to come in or they will realize it is to their benefit to join the union at some point. Going it alone is not the best option,” says John Sfakianakis, chief economist at Banque al-Saudi al-Fransi.

The realization that monetary union without the UAE makes little sense, could trigger renewed efforts to bring Abu Dhabi back into the fold.

“It’s no longer a common currency if two of the six are missing,” says Marios Maratheftis, Dubai-based regional head of research at Standard Chartered Bank. “I wouldn’t be surprised if there are backstage discussions to see if there’s a way to get the UAE back in pushing the project forward, but there is unlikely to be any significant progress by 2010, which was the original deadline for monetary union.”

There is still much to salvage from the wreckage, and the four single-currency backers may press on with preparations for a single currency even without Abu Dhabi’s participation. “Everyone has accepted that the original 2010 deadline will not happen, but the institutional drivers are in place in as much as there is now an agreement where the Monetary Council will be located,” says Jarmo Kotilaine, chief economist at NCB Capital.

The GCC customs union, in place since 2008, has provided some of the institutional undergirding for a single monetary area. But the member states’ fiscal and monetary policies have diverged in the aftermath of the sub-prime crisis. Gulf states have had to revisit their monetary policies after the high inflation experience in 2007–08 when oil prices ballooned and commodity prices went sky high.

Now may be an opportune moment to see if any of the convergence criteria need to be revised, concentrating on the technical legwork, rather than the grand political vision that has hitherto proved elusive.

The most credible target date for monetary union is now 2013. This is still far enough in the future to allow preparations to be completed in a realistic time frame. That deadline is also early enough to serve as a credible source of discipline to the GCC. That said, the stark fall-off in hydrocarbons revenues since mid-2008 could make it that much harder to meet monetary convergence targets.



DOLLAR PEG DOLDRUMS

If the dollar comes under renewed pressure, amid steadily rising oil prices, old disputes about what to do about the dollar peg could yet stymie progress. “There shouldn’t be a major disruption in terms of the convergence process,” says Kotilaine. “Things are out of whack right now because of the budget deficits and the fiscal stimuli implemented in response to the economic crisis, but I think we can look forward to a gradual reconvergence.”

But some analysts point out the still marginal economic benefits of a single currency to members, perceiving the push towards a single currency as a political project masked as economics.

One of the main benefits of a common currency is an improvement in intra-regional trade. Yet, trade in the Gulf is dominated by hydrocarbons exports to Asia, North America and Europe, leaving little material benefit for member states with far less significant trading relationships with one another than with the outside world.

“Less than 10% of the UAE’s trade is with other GCC states,” says Maratheftis. “And even if there is currency union, there is little fluctuation between the Gulf currencies – they have had a de facto common currency for decades with the dollar peg.”

Saudi Arabia, which has emerged as the leading voice for monetary union, may have to decide whether to adopt a more conciliatory line, and encourage Abu Dhabi to reconsider its opposition by offering concessions.

“The European Central Bank was situated in Germany, the EU’s largest economy, but they made the first chairman a Dutchman. The same options exist in this region too,” says Kotilaine. Even if the UAE does recommit to the project at some point, the GCC still faces a massive task in merging national currencies and making that venture a success.



REMIT UNCERTAIN

“It’s unclear as to what the size and shape of the central bank will be, and what its remit will be – whether it takes on a role of something more than a monetary policy-maker, and becomes responsible for financial regulation and supervision,” says Kotilaine.

The next year could witness further political grandstanding, as the most influential Gulf states mark out their positions on fundamental issues of economic and political integration. If compromise is reached on key issues, the monetary union project will find renewed momentum.

The advocates of monetary union say the ultimate prize goes well beyond the immediate economic benefits of improved trade. “The GCC will do well with or without monetary union, but it will add to the region’s ability to appear much more functional as a unit than as a group of six separate states,” says Sfakianakis.

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