Political motivations underpin debate on monetary union

03 September 2004
The economic criteria for a successful monetary union are relatively straightforward. Pegged to the dollar and so already both monetarily similar and constrained in the use of monetary policy tools, the GCC economies meet the majority of the conditions. However, the mechanics of establishing the rules and institutions of currency union present a whole different set of challenges. And the six governments have only five years and four months to meet them.

A technical committee, composed of senior officials from regional finance ministries under the auspices of the Riyadh-based GCC Secretariat, has been allotted the politically charged task of mapping the process. 'The headline deadline is that currency union will be implemented by 2010, but extensive preparation is necessary so there is a fairly rigid sub-schedule in place,' says Nasser al-Qaood, head of financial and monetary integration at the GCC Secretariat. 'The technical committee meets regularly and all the institutions are due to be in place by mid-2007.'

The committee has been tasked with three major areas of consideration. The first of these was the development of the common currency peg to the dollar, which was achieved in December 2002 when Kuwaiti became the last of the six states to tie its exchange rate to that of the US. Qatar, Saudi Arabia and the UAE are on a ratio of about 3.5:1 with the dollar, while Bahrain, Kuwaiti and Oman are at about 0.3:1. The snake is already in the tunnel. Interest rates have remained broadly in step, although Kuwaiti has recently moved out of alignment with the rest following an increase of 50 basis points by the Central Bank of Kuwaiti (see chart).

The second committee mandate is to agree on the convergence criteria for the six economies, an issue that remains the subject of intense discussion. Unsurprisingly, the eurozone experience is being studied closely. In the EU, the Stability & Growth Pact limits the budget deficit to 3 per cent of gross domestic product (GDP) and government debt to 60 per cent of GDP, with states theoretically subject to financial penalties for non-compliance. However, the pact has proved one of the most controversial aspects of EU currency union, and the bigger players in the club, such as France and Germany, have flouted it with impunity. Many European governments argue that members should be allowed to break the rules where fiscal stimulus is needed to cure economic depression.

'We are looking very closely at the European model on limiting the budget deficit and public debt,' says Al-Qaood. 'However, we have not taken any decision on the levels at which GCC limits will be set. Given the similarity of our economies, and other facilitating factors such as the common language, the process is likely to be easier. Criteria are due to be in place by the end of 2005.'

The secretariat's third task is perhaps the most politically fraught, settling on the mechanics and locations of the union's institutions. 'We are looking at three options,' says Al-Qaood. 'The most extreme option sees the complete abolition of national central banks and a single central bank taking over all the functions. At the other end, there is the option of the central banks maintaining almost all of their current functions and just co-ordinating over a single currency. In the middle, central banks would maintain a supervisory and co-ordination role while the single currency would be managed by the GCC central bank.'

The committee is also looking at issues such as where the central bank should be located and where the currency will be printed. Given the dominance of the Saudi economy in the union, the assumption is that Riyadh will end up as the hub, although the Bahrain Monetary Agency (central bank), in its role as the unofficial Gulf financial centre, is likely to present a strong case.

Such decisions are difficult and political sensiti

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