Single market outweighs currency union

16 November 2007
Despite speculation over the future of a GCC single currency, member states refuse to abandon their dream of mimicking the success of the euro. However, creating a single market could be more beneficial.

There was a sense of inevitability when one of the region’s most cherished economic integration projects ran into trouble earlier this year. Oman’s admission that it would not meet the 2010 deadline for monetary union, and its decision to exit currency union plans, exposed the dichotomy that exists between the desire of GCC states to retain sovereign monetary policies and their ambitions to mirror the EU single currency.

Europe’s model remains a guiding light for the GCC. “There is inspiration from the EU, for what they achieved in the single currency,” says Zakariya Hejres, deputy chief executive officer of Bahrain’s Economic Development Board.

The reality is the Gulf is not quite there yet. The GCC might have coped with one member not participating - after all, the euro has prospered without UK participation. But Kuwait’s decision to drop its currency peg to the dollar in May 2007, scrapping a previous agreement to keep it in place until 2010, dealt a body blow to the six states’ aspirations to ditch their national currencies.

Shaky foundations

Regardless of gripes about loss of national control over monetary policy, the conditions justifying a dollar-pegged single currency have rapidly eroded because of US currency weakness.

Kuwait hitched to the dollar in 2003 as part of the GCC’s preparation for a single currency. But the inflationary spike that triggered its decision to depeg reflects a wider dysfunction in the global economy. While hydrocarbons-rich GCC states have been busily posting multibillion-dollar fiscal and current account surpluses, the US economy has been battling with other problems that necessitate a competitively valued currency.

By building a single monetary system on the shaky foundations of a weak dollar, the GCC has got the timing all wrong. The khaleeji coin is highly unlikely to be jangling in Gulf pockets come 2010. The GCC’s challenge is to rescue the project from the claws of economic and political recrimination. In public, at least, the GCC is still committed to the project. “I assure you there will be no delay in meeting the target of 2010,” Abdul-Rahman al-Attiyah, GCC secretary-general, reiterated at its annual meeting in Amsterdam on 31 October.

Yet with influential central bankers such as the UAE’s central bank governor Nasser Sultan al-Suweidi casting doubt on timeframes, the public pretence that all is well with 2010 looks unconvincing. Indeed, the region’s monetary authorities are pushing a rather different line. In October, GCC central bank governors presented the case for postponing the 2010 deadline to a meeting of finance ministers in Riyadh. The ministers rejected the proposal, arguing there were insufficient grounds to recommend a delay to heads of state, who are due to meet in Doha in early December.

Instead, they asked the GCC monetary union committee and central bank governors to draw up a timetable to be submitted in 2008. This delay could help get plans for a single currency back on track.

“From that timetable we will be able to see where the bottlenecks and delays might emerge,” says Abdulaziz Alauwaisheg, director of economic integration for the GCC.

Convergence criteria

Despite media reports that the December summit of GCC heads of state will set a firm deadline for monetary union, a decision is unlikely. The GCC authorities are not about to be hurried on such a strategically vital issue, say observers.

With Oman deciding to sit out of monetary union, some have suggested a two-speed process might allow the 2010 deadline to be met. Officials are hinting at such a move. “If I look at the euro and the EU, some countries are not part of that monetary unification,” says Al-Attiyah.

However, a dual-speed move to a single currency is not officially under discussion.

The convergence criteria have been agreed: inflation should be no higher than 2 per cent above weighted GCC average; interest rates no higher than 1.5 per cent above the GCC average; fiscal deficits less than 3 per cent of GDP; national debt less than 60 per cent of GDP; and reserves at less than four months import cover. But individual member states still have to implement these strictures.

The overwhelming focus on monetary union is understandable given the confusion in the region’s currency markets this year and Kuwait’s decision to depeg - prompting a wave of speculation that Saudi Arabia would follow suit. But the undue emphasis given to the single currency is also a concern for observers.

“Even if you had a single currency, it would not immediately increase trade,” says Eckhart Woertz, economics programme director at the Gulf Research Centre. “You need other administrative and legal requirements in place.”

A single currency would boost intra-GCC trade, besides reducing foreign exchange risk and slashing transaction costs. But the real benefits depend on other pieces of the puzzle being put in place - a message taken on board by the GCC. “You could argue that the benefits of a single currency are going to be greater once we have achieved other levels of integration,” says Woertz.

“We have had customs union since 2003 and the results are phenomenal compared with our initial expectations,” says Alauwaisheg.

Trade was expected to expand by up to 30 per cent in the first four years of customs union. In fact, it has been growing by 20 per cent a year on average since 2003.

Market potential

The next big project on the horizon is the single market, which is due to be formally launched at the December summit in Doha to hit the end of 2007 deadline for completion. A growing consensus suggests single-market reforms would pack a stronger punch than a single currency, with all the benefits accrued by the free movement of goods, services and labour.

Some key ingredients of a single market are already in position. Customs union has imposed a common external tariff of 5 per cent and removed customs duties between states. The arrival of flexible labour markets would give a decisive push to investment and the development of a genuinely borderless GCC economy. In June this year, GCC labour ministers agreed a draft unified labour law, which revises the sponsorship systems that tie expatriate workers to their existing employment.

When similar measures are implemented, a single currency might have the effect that its converts hope for. “If we have a single market, the trade in services between member states could be so large that monetary union would produce a great effect,” says Alauwaisheg.

He says the impact of a single currency depends on the extent to which member states are integrated. “Up to now, they are integrated in terms of trade through the customs union, but we hope they will integrate even further by completing a common market through investment and services.”

Equally tantalising is the prospect of the long-delayed free trade agreement between the GCC and the EU finally being signed. Existing trade relations are governed by the EU-GCC co-operation agreement dating back to 1988, but momentum has been growing on both sides to sign a full trade pact granting preferential treatment and the fuller opening of each other’s markets.

The Gulf represents the EU’s fifth largest export market, and the EU is the GCC’s largest single trading partner. The EU imported more than e37bn ($54bn) worth of goods from the Gulf region in 2005, while e50bn worth of goods were sent to the Gulf from the EU.

The EU wanted to seal a free trade agreement under the German presidency of the EU, which ended in June 2007. Now that an agreement is finally in sight, excitement levels are growing. The next round of EU-GCC trade talks begins on 26 November and the EU is putting together the final text of an agreement. “This would look like a final product even if there are still questions and things need changing,” says an EU trade spokesperson. “Then we can start to work on the final product and take it to the next negotiating round.”

Free trade

The areas of difficulty relate to the GCC’s dislike of the quantitative restrictions. This is a red line for the Europeans. “If you have a prohibition of quotas in the agreement that would mean you no longer have a free trade agreement,” says the Brussels official.

The EU is pressing hard on issues like the sale of oil products and preferential treatment for EU member states in government procurement. But a compromise deal may be close. A GCC negotiating team earlier this year proposed that by the end of 2007, the two sides should sign an agreement based on what has been agreed by that time, and defer other issues to post-signing negotiations. If that is accepted in the late November round, an agreement could be signed this year.

“The benefits that are going to accrue will depend on post-signing actions, meaning the two sides utilising the mechanisms included in the agreement, meeting regularly and trying to put some substance to the agreement,” says Alauwaisheg. “Then the results will be good.”

By early December, it should become clear whether a GCC-EU deal will be months or weeks away. But it may take even longer for Gulf ministers to agree the trickier details of a single currency. Dinars, dirhams and riyals will be changing hands for a while longer yet.

Credit ratings

Government surpluses have improved GCC sovereign ratings but political vulnerabilities and data reliability are holding back further gains.

There has been a dramatic strengthening of government balance sheets in foreign currency between 2002 and 2007 as fiscal and current account surpluses have widened, according to a note on GCC sovereigns issued by ratings agency Moody’s Investors Service in early November. This is despite a strong pick-up in government expenditure and imports.

In 2007, the IMF predicts the GCC’s combined central government surplus will amount to about 20 per cent of GDP, with Kuwait recording a surplus in excess of 35 per cent of GDP, among the highest in the world.

Real GDP growth in the GCC will average 6.8 per cent between 2003 and 2007, compared with 3 per cent between 1998 and 2002. The GCC’s combined nominal GDP will have more than doubled since 2002, to almost $800bn in 2007.

These performances have compelled ratings agencies to upgrade GCC sovereign ratings.

Since 2003, Moody’s has upgraded all six GCC member states’ foreign currency government bond ratings by between two and four notches. These ratings now range from A2 for Bahrain and Oman to A1 for Saudi Arabia, and AA2 for Kuwait, Qatar and the UAE, suggesting a low risk of default. The large stockpiles of foreign currency GCC governments have built up would act as a valuable stabiliser during any period of political turmoil, for example.

The interesting question is why the ratings are not higher still. Moody’s gives three reasons why GCC states are not in AAA territory. One reason is the relative political instability of the region, which distinguishes GCC sovereign credits from those rated AAA.

The second factor is the immature state of GCC institutions, with weaker quality of governance including the effectiveness of countries’ administrative and legislative systems. Reliability of economic data is also a concern.

Moody’s also highlights the changeability of economic performance. The median standard deviation of annual real GDP growth over the past 20 years for AAA-rated countries was 1.6; for GCC countries it was 4.9. The reason? The heavy concentration on oil and gas, despite progress towards diversification.

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