x Abu Dhabi, UAEMonday 24 July 2017

Euro provides a timely message for Gulf union

A single currency in the region has been mooted for some time and as the GCC moves towards formulating concrete plans, the EU model is a cautionary tale.

Gulf policymakers are likely to be among those anxiously watching the growing sovereign debt crisis in southern Europe. As fears persist over the risk of Greece's debt problems spreading across the Mediterranean into Portugal and Spain, there are concerns in the Gulf that the turmoil could have implications much further afield.

Plans for setting up a GCC monetary union have been heavily inspired by the model used to establish the EU and its currency, the euro. The European Central Bank (ECB) has even provided technical support as part of the preparatory work for the GCC single currency project. Cynical observers have gone as far as to suggest that GCC officials have largely copied the Maastricht Treaty, which drafted the blueprint for the EU.

However, with the EU acting as a trailblazer for the establishment of a monetary union globally, it makes sense for the GCC to model its preparations on the EU. At the same time, though, risks exist in basing the regional version on a framework that seems to have failed in its aims to promote cross-border economic stability. Greece's debt problems have starkly exposed what could be weaknesses within a monetary union. Despite a significant budget deficit, Greece was allowed to join the EU in 2001.

Once within the EU, Greece set about using its membership to borrow cheaply to finance its deficit. Warnings about the country's deteriorating fiscal health from EU checks were largely overlooked. Greece's strategy finally unravelled when the global financial downturn raised the cost of plugging its bulging deficit. Despite a €110 billion (Dh512.96bn) bailout of Greece and the agreement of a €750bn emergency package to safeguard the euro, fears persist about a sovereign debt crisis cascading through southern Europe.

Fortunately, the economies of the Gulf are starting from a much firmer fiscal footing and no GCC state has ever defaulted on its sovereign debt. A strengthening of the oil price will help to rebuild the fiscal accounts of GCC governments drained by hefty stimulus packages rolled out in the financial crisis. Of the GCC, only Bahrain is expected to post a budget deficit this year. This means the economies and budget capacity of the GCC states are stronger and more closely aligned compared with the fiscal imbalances among euro zone countries.

Furthermore, it is considered unlikely that a GCC single currency would replicate the severe decline of the euro should a similar crisis emerge in the region. A peg to the US dollar, which is considered the most likely option for the regional currency initially, should help stability. All GCC members except Kuwait peg their currencies to the dollar. The euro has slid in value against the dollar and the Japanese yen in recent weeks as markets remained threatened by further credit rating downgrades within the euro zone.

Perhaps the most stark lesson the GCC can learn from the EU model is to be realistic about what a monetary union could achieve. "In the EU, it was a mistake to present an optimistic view of what the gains of the monetary union would provide," says Jacques Cailloux, the chief European economist at Royal Bank of Scotland. With the GCC's plans still at a formative stage, economists argue officials need to ensure they avoid the shortcomings of the European system in their planning.

"The GCC will be able to benefit from the mistakes of others," says Jarmo Kotilaine, the chief economist of NCB Capital of Saudi Arabia. "This highlights that grand visions are not enough to achieve monetary union plans. They need to get down to the nitty-gritty of ensuring risk management plans are robust." When officials from Saudi Arabia, Kuwait, Qatar and Bahrain hold their meeting next month it would be a surprise if the crisis gripping the euro zone were absent from the topics on their agenda.

March marked a crucial step in the realisation of a regional union with the first official meeting of central bank officials from those four GCC states as part of the monetary council, which is likely to be the forerunner of the proposed union's central bank. With the council in place, attention now turns to the complex process of establishing the technical and legal framework for the union under the guidance of the monetary council.

Harmonising regulations, payment and settlement systems and economic data, agreeing on the appropriate exchange rate regime and pooling foreign exchange reserves, along with reserve management policy, are among the vital steps to be considered. It is the measures taken during this early planning that are likely to determine whether the project is successful and sustainable. The refusal of members of the council to put a deadline on the formation of the monetary union could allow breathing space if a decision is made to reassess the details of their proposals after the euro zone crisis.

"Even some of the European leaders, like the German chancellor Angela Merkel, have admitted there were some mistakes in the inception of the euro zone and there may need to be some adjustments within its composition," says Christian Koch, the director of international studies at the Gulf Research Centre in Dubai. EU politicians in Brussels are expected next week to vote on more stringent controls of hedge funds and on centralising supervision of financial markets as they seek to learn from the financial crisis and fill gaps in the EU model.

Perhaps the biggest challenge for GCC officials is to ensure sufficiently robust management of the fiscal framework once it is established. "In the EU's case the basic mechanisms were good but they were ignored by countries such as Greece," says Mr Kotilaine. "This highlights the need for proper statutory controls across the GCC based on proper processes, and this is where the economies have a lot of work to do and need to have mechanisms in place to deal with a crisis."