Monetary union faces new reality in Gulf

05 January 2011

Momentum for currency union has declined steadily in the past five years. The GCC Monetary Council faces a tough challenge in reviving support for the project

Key fact

Four GCC states still committed to monetary union are Saudi Arabia, Kuwait, Qatar and Bahrain

Source: MEED

As the original deadline for achieving monetary union among the six member states, 2010 was supposed to have been momentous for the GCC. Instead, the bloc’s strategic planners must face up to a harsh reality: a Gulf single currency remains a dim and distant prospect. And much of the political capital behind the creation of a unified central bank has already been expended.

Our priority will be to draw up the legal and organisational framework for the central bank

Muhammed al-Jasser, GCC Monetary Council

The problems encountered by the eurozone economies over the past year have not helped the case for the Gulf monetary union. But even if the euro had not slipped into crisis, it was already hard to evoke enthusiasm for the Gulf currency union.

On paper at least, the GCC remains committed to creating the institutional framework for currency harmonisation. In March 2010, Muhammed al-Jasser, governor of the Saudi Arabian Monetary Agency (Sama) was elected as the first chairman of the GCC Monetary Council, the body set up in 2009 to pave the way for a regional central bank.

Key interest rates
US Federal Reserve0.25
Bahrain overnight deposit rate0.25
Saudi reverse deposit rate0.25
Kuwait overnight deposit rate0.75
UAE repurchase rate1
Qatar deposit rate1.5
Source: Credit Agricole, November 2010

Tough mandate for Gulf monetary council

The monetary council will be located in Riyadh, the home of Sama, the most powerful central bank in the GCC. The much-respected Al-Jasser, who took over as head of Sama in February 2009, has already shown a deft handling of the kingdom’s economy in the wake of the global economic crisis. Using countercyclical monetary and fiscal policies, Al-Jasser ensured the kingdom’s banking system remained liquid throughout the downturn.

New targets have not been set … Work is progressing, but at this point it’s at level of technical preparation

Jarmo Kotilaine, National Commercial Bank

Now, Al-Jasser faces an altogether different task. He has to build a unified monetary and financial system with a strong central bank, leveraging the support of the four GCC states still committed to union – Saudi Arabia, Kuwait, Qatar and Bahrain.

It is a big challenge, given that the momentum towards a single currency has steadily declined in the past five years. It was first undermined by the withdrawal of Oman and then the UAE. The latter opted out in May 2009, after Abu Dhabi was passed over as the proposed location for the monetary council in favour of Riyadh.

Monetary union is also a much less fashionable topic than it was 10 years ago. Al-Jasser’s major job, assisted by his deputy, Central Bank of Bahrain governor Muhammed Rasheed al-Maraj, is to revive a sense of purpose for the need to link the Gulf’s major currencies. He also has to deliver the full raft of benefits that a unified ‘Gulfzone’ economy promises.

Gulf benchmark lending rates, 2010
Saudi Arabia repurchase rate2
Bahrain overnight repurchase rate2.25
Kuwait discount rate2.5
Qatar overnight lending facility rate4.4
Source: Credit Agricole, November 2010

On taking over the chairmanship, Al-Jasser said his initial aim was to establish the GCC central bank, prioritising institutional and regulatory framework over grand ambitions. “Our priority will be to draw up the legal and organisational framework for the central bank. This will be done in coordination with the central banks or monetary agencies of the member countries,” he said.

First, however, the Sama chief must ensure that the GCC Monetary Council itself is fit for purpose. The institution’s basic role is to set up central bank and, once that is operational, allow the central bank to take over.

Much of the monetary council’s work so far has been fairly mundane, focused on technical preparations for monetary union among the four states signed up to it.

Although it is still early days and Al-Jasser already has a full-time job as head of Sama, alongside his duties as chairman of the monetary council, the in-tray is rising.

“In technical terms, there is a lot still to be done, including establishing and staffing relevant institutions, agreeing on appropriate monetary policy tools, harmonising and improving economic and financial statistics,” says Daniel Kaye, chief economist at National Bank of Kuwait. “It also involves providing businesses and consumers with a concrete timetable for the eventual switch of currency so that they can adapt.”

Broader issues for Gulf monetary policy

There are also broader macroeconomic issues, concerning monetary policy objectives and the choice of currency regime. Some of these issues are political in nature and could take some time to hammer out, says Kaye.

Little has emerged into the public realm about progress on key objectives. However, the monetary council – comprising the four states’ central bank governors – did debate procedures in the summer of 2010 to set up the organisational and institutional framework of the council. It also discussed the creation of an executive authority that would outline plans for the currency union and implement decisions.

One part of the council’s brief is to cajole member states into good behaviour. A statement issued by the council in mid-August stressed the need for the central banks in member states to achieve more convergence in monetary policies and alignment in national currency exchange rates.

A key issue facing the monetary council is that it only has coherence as a forerunner to a formal GCC central bank. To some extent, this will circumscribe its authority.

“The monetary council is important in the sense that it is the first step before the introduction of a GCC central bank. A GCC central bank is a pre-requisite for monetary union and the introduction of a common currency,” says Marios Maratheftis, a Dubai-based senior economist at the UK’s Standard Chartered Bank. “In the absence of monetary union, and more importantly a clear roadmap for the introduction of a common currency, the role of the monetary council will be limited.”

Political challenges for Gulf currency

Addressing the political challenges of a unified currency will likely be more tricky than the technical detail involved in piecing together a workable central bank.

 In light of Riyadh’s strong push for monetary union, Al-Jasser must ensure this is not mistaken for the accumulation of further power to Saudi Arabia, which already hosts the GCC Secretariat and is the region’s dominant economy.

The absence of Abu Dhabi from the project has already dealt a blow to the monetary union, and it will take more than institutional fine-tuning to get the UAE back on board.

“They have work cut their out,” says Jarmo Kotilaine, chief economist at Saudi Arabia’s National Commercial Bank. “There are people in the region who think the whole thing will never happen and that there is not the political maturity to go for integration. 

“While I see where the argument is coming from, the reality is the GCC has become something more than just a talking shop. They have worked on initiatives, some of which have materialised, and although the execution times tend to be quite long, the work is ongoing.”

There is still a strong support for continuing with preparations for monetary union, even if the political argument has not yet been convincingly won. “There are things the monetary council can do even if union is delayed. For example, they can work on policy coordination, which is an important issue for the region and one whose potential has not even come close to exhaustion,” says Kotilaine.

The monetary union will remain in the preparatory phase for the time being, as some of the key economic aspects have not yet been worked out, including the question of the dollar peg.  

Although the dollar-pegged GCC currencies have emerged relatively unscathed from the global economic crisis, inflation is a significant long-term problem, and the region has a marked vulnerability to imported inflation. This will pose questions over the sustainability of linking a unified currency to dollar.

The eurozone crisis of 2010, in which EU member states suffered massive financial problems has been attributed to the failure of the European Central Bank to adequately address the massive disparities between the eurozone economies. It is a stark remainder for the GCC states about the need to think long-term when planning major regional economic readjustments. 

The GCC Monetary Council must defend the project from the criticism that it is walking straight into the same trap as Europe. The Maastricht convergence criteria of the EU formed the same template used by the GCC to devise its own. “Structurally, the GCC economies are more closely aligned with each other than Europe, reducing the dangers associated with a common monetary policy. But it does not eliminate the risks completely,” says Kaye.

“Moreover, given their varying levels of remaining oil resources, Gulf economies could become less closely aligned in future, creating European-style policy dilemmas.

“The recent European experience highlights the need for a unified fiscal policy to support a single currency. Although most Gulf states appear to be able to stand on their own two feet in fiscal terms, a single policy may be much more difficult to achieve.”

The bitter experience of seeing target dates for monetary union lapse will ensure that any future deadlines are likely to be kept private. Some analysts say that public commitments to dates help concentrate minds, even if the exact dates are sometimes missed. Other commentators point out that setting artificial deadlines can be self-defeating, and that setting another unrealistic date could undermine the credibility of the project.

“New targets have not been set for monetary union. Work is progressing, but at this point it’s at level of technical preparation. Once a clearer idea emerges of where politicians want to take the thing, then they will start to talk about target dates,” says Kotilaine.

There is much still to play for and some of the necessary work is beyond the strict remit of the GCC Monetary Council. There is a need to harmonise regulations, payment and settlement systems and economic data, to get to a point where monetary union could be feasible.

Voting rights for Gulf states

Furthermore, the central bank’s assets need to be determined. Voting rights between member states will also have to be decided. In the EU, member states enjoy equal voting powers. The lopsided nature of the Gulf economy, with Saudi Arabia accounting for almost half the GCC’s combined gross domestic product, might prevent that.

Al-Jasser and his colleagues in the monetary council have a unenviable task in forging a new institutional apparatus from the problems of the past few years.

Focusing on the small details will clearly help to sustain the momentum for monetary integration. “They should not set the bar too high,” says Kotilaine. “There’s a lot you can do in terms of the day-to-day, nitty-gritty of regional integration if you want to turn the project into success. That is where attention is focusing much more.”

Al-Jasser’s bigger challenge is to win the economic and political argument over the benefits of monetary union.

One of the reasons why the EU now has a bad reputation in eyes of many Europeans is that it has been focusing too much on lofty and vague goals as opposed to concrete economic benefits.

The lessons will no doubt be learned, but Al-Jasser may be inclined to keep a low profile as he carefully stewards the council to meet the long-term objective of creating an integrated monetary and financial system.

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