The UAE’s withdrawal from the GCC monetary union project in May delivered a major blow to the GCC’s pretensions of becoming an economic superpower. The country’s exit from the project was triggered when the council decided to locate the GCC Monetary Council, the likely precursor to any GCC central bank, in Riyadh rather than the UAE capital Abu Dhabi.
The UAE’s ongoing rivalry with Saudi Arabia has always posed a risk that the GCC might never be able to agree on significant issues such as economic integration.
Abu Dhabi’s decision to opt out is not the only obstacle to have hit the Gulf’s monetary union plan. Momentum has also been sapped by Oman’s announcement at the end of 2006 that it would not join the single currency by the then deadline of 2010, and by Kuwait’s decision in 2007 to abandon its dollar peg in favour of a peg to a basket of currencies, making its integration more complex.
Serious questions continue to hamper the Gulf single currency project, even while the four committed member states vow to press on. Saudi Arabia, Kuwait, Qatar and Bahrain are still committed to the project, but without the UAE, the GCC’s second-largest economy, the single currency could struggle for impact and credibility.
It has been suggested that the Gulf should operate a two-speed process that leaves the door open to the UAE and Oman to join at a later date, but the merits of this option are also in question for the remaining four states.
Given the marginal economic benefits of a single currency to countries that, with the exception of Kuwait, already have their currencies pegged to the dollar, a four-member group would be unlikely to accrue the full benefit of monetary union, principally currency stability. Many of the gains from the removal of exchange rate volatility in the EU, where 11 of the bloc’s members established a currency union in 1999, are irrelevant in the GCC’s case.
“The direct economic benefits of monetary union are not that great, simply because they already have long-standing, credible exchange rate pegs,” says Paul Gamble, head of research at Riyadh-based Jadwa Investment. “It is not like the eurozone where there was prior volatility between currencies that would inhibit trade. And everyone in the GCC produces much the same goods.”
According to a study published in July 2008, Prospects for a Single Currency in the Arabian Peninsula, by Emilie Routledge, assistant professor of economics at the United Arab University of Al-Ain, there would be no benefits from monetary union for Kuwait and Qatar. Ironically, the benefits of monetary union outweigh the costs for the two Gulf states that have pulled out of the project: Oman and the UAE. The reliance of the UAE, in particular Dubai, on non-GCC trade means it would benefit from greater currency stability.
Although no one is saying it publicly, currency union without the UAE makes little sense. The country accounts for a quarter of the GCC’s gross domestic product (GDP), and serves as the main commercial hub, linking the Gulf to the rest of the world via extensive trade relationships.
But this does not mean a two-speed monetary union process is necessarily without value. “The reality is that if monetary union comes into play, the UAE is highly likely to join at some point,” says Jarmo Kotilaine, chief economist at Saudi investment bank NCB Capital.
For Saudi Arabia in particular, it is imperative to keep the monetary union process on track, as it does not want to endanger the long-term strategic benefits of a unified trade bloc, of which a single currency is a core com-ponent.
“The two countries that decided to be excluded should not be allowed to hijack the process and prevent the other four from moving ahead,” says John Sfakianakis, chief economist at Banque Saudi Fransi.
The global economic crisis has made monetary union more problematic, the turbulence in the price of oil since mid-2008 making it increasingly hard for GCC governments to determine their own revenue streams let alone those of their neighbours, according to Routledge’s analysis. These countries’ ability to meet and monitor monetary convergence targets – such as the fiscal deficit not exceeding 3 per cent of GDP – between now and 2010 will be hampered.
Much more groundwork is needed to make currency union a viable goal. Aside from a series of tricky institutional arrangements, the bigger task is ensuring political consensus, particularly between Riyadh and Abu Dhabi.
The UAE’s anger at the decision to locate the Monetary Council in Saudi Arabia was understandable – as an official statement noted at the time, the UAE does not currently host any organisation or body affiliated with the GCC. The issue is more than a symbolic battle. The Monetary Council could emerge as the most important GCC institution after the GCC Secretariat, which is based in Riyadh.
Abdulrahman al-Attiyah, secretary general of the GCC, justified the decision to base the Monetary Council in Riyadh on the basis that Saudi Arabia is the only regional member of the G20 group of industrialised nations. A large part of the kingdom’s pitch is that it is emerging as a credible global financial hub.
There are other issues at stake. The UAE has, for example, articulated a different vision for the proposed central bank than Riyadh. Abu Dhabi’s preference is for a decentralised system, possibly allowing for the retention of domestic currencies, while Riyadh’s view is that it should be centralised, autonomous and hold full responsibility for managing the single currency.
Some UAE officials fear that with a de facto central bank located in the kingdom, monetary policy will follow an agenda set by Saudi Arabia. But since the UAE’s decision to withdraw, Saudi officials have adopted a more conciliatory approach.
Saudi Arabia is wary of the risks of allowing the Monetary Council to be viewed as a Saudi institution. It may therefore be ready to cede governorship to a senior UAE official. “It is unrealistic to expect the decision to locate the Monetary Council in Riyadh to be reversed, but the experience of the European Central Bank has shown that there are other ways to cater to the UAE’s concerns,” says Kotilaine. “They [the UAE] could get the top job, or they could base some of the bureaucracy in the UAE. This could one day include the basing of a GCC-wide financial regulator in the UAE.”
There is much still to play for, even if the initial victory has been Riyadh’s. Regulations, payment and settlement systems and economic data need to be harmonised. The central bank’s assets must be determined and voting rights decided. In the eurozone, EU members have equal voting power regardless of the size of their economies and populations.
Given the Saudi economy’s sheer weight, accounting for almost half of the GCC’s combined GDP, a similar system in the Gulf might help to reassure sceptics.
But if Saudi Arabia is prepared to compromise, others will also have to give way. “This is not a zero-sum game,” says Sfakianakis. “Member states should not see the GCC simply in terms of hosting institutions. Of far more importance is the issue of the powers and sovereignty of the institution, which will be far more crucial in the suitability of the central bank than where it will be or whether its governor comes from Abu Dhabi.”
Similarly, member states may have to accept that some are more equal than others. “They must realise that one or two countries will guide and steer the rest,” says Sfakianakis. “The sheer weight of Saudi Arabia and the UAE will play a major role in steering this attempt to unify the economies.”
None of these issues is insurmountable. No member state has said it would never join a single currency and the arguments over the Monetary Council’s location should not distract it from resolving key issues such as the exchange rate regime, how it will manage foreign exchange, and the name and shape of the future Gulf currency.
Gulf governments have been lax at explaining the benefits to their populations. “There is a huge disconnect between what the GCC is doing and what the citizens of the GCC are perceiving that they are doing,” says Sfakianakis. “They [the authorities] have failed to inform the public why they are moving to a single currency.”
Currency union is part of a larger effort to create an economic union, which will allow the region to negotiate with one powerful voice. It is a key part of an integration process that will enable the Gulf to compete better on the global stage. The rewards are such that if it successfully forges a monetary union, the GCC could eventually emerge as one of the top five global economic blocs.