Abu Dhabi, UAETuesday 11 December 2018

Lessons the euro can offer the GCC on monetary union

The UAE's decision stems from far more than an emotional reaction to losing the location of the GCC central bank to Riyadh.

While the discussion about a unified GCC currency and its peg against the dollar has taken the limelight, the broader process of an integrated economic system for the GCC that might emerge from the birth of monetary union is more important. The global financial turmoil has not only thrown in doubt previously held beliefs about regulating the banking system, but also raised some unthinkable questions, such as the future of currency blocs like the euro.

The same uncertainties about the direction and approach in managing the financial crisis seems to have affected GCC countries, with the UAE believing that an open and liberal regulatory regime is still valid, while Saudi Arabia has opted for a more regulated regime. Once again the EU model stands out. The UAE's decision to withdraw from a GCC currency union echoed Britain's decision to opt out of a common currency.

The UAE's decision stems from far more than an emotional reaction to losing the location of the GCC central bank to Riyadh, but more on a deep seated belief that a conservative regulatory regime based on Saudi Arabia's dominance and influence on the unified GCC central bank would dash the UAE's, and specifically Dubai's, continued belief in an open economy model, which in turn might threaten that Emirate's future expansion as a global financial hub.

In Europe, similar dilemmas prevail. As member states grapple with different domestic economic and financial stabilisation policies, the euro is under strain. The pressure comes from economic sick men of Europe such as Ireland, Greece, Italy and Portugal. While Britain's deficit is essentially a matter of national grief, as Britain opted out of the euro and has let sterling float at the whims of the financial markets, Ireland's deficit, and those of Spain, Greece, Italy, and Portugal, are not. They all have to share the euro with the Germans. One problem is that the Germans may soon get a little impatient at the financial mess being created all around them.

Ireland joins Spain, Greece and Portugal in having their sovereign debt downgraded. The markets are already demanding a "risk premium", the evidence of increased tension expressed in the spreads of bond yields on German government debt over the weaker periphery countries. The same dilemma will apply to Saudi Arabia, the dominant Gulf economy which will see its role as underpinning the combined Gulf currency and its international rating, hence Riyadh's insistence on hosting the GCC central bank.

To understand the euro, one must realise that it is about history and not just economics. The Germans are ideologically committed to the euro. Since Helmut Kohl, at least, it has been an unwritten article of German nationhood to anchor the federal republic in the European project. But even in the Kohl era, there were limits to that ambition. Hence the strictures on budget deficits and national debt in the Maastricht Treaty, which framed the euro and left the UK with its famous "opt out" clause.

The cement of history is a lot stronger than economics and budget deficits, but can this be sustained for ever? True, the treaty was never designed with the credit crunch in mind and it provides wriggle-room. Nonetheless, the Maastricht criteria were the next best thing to a Europe-wide Treasury controlling the budget deficits of member states. The same applies to the proposed GCC monetary union and the decision to have Riyadh the headquarters of the GCC central bank: this is Saudi Arabia's statement of its matter of faith that the GCC monetary union will go ahead for geopolitical and economic reasons.

The global financial turmoil is putting a strain on countries and soon, however prudent they are, the Germans may run out of cash, if not patience. The problem with the euro is that it suffers from not having a single Treasury function behind it. None of this would matter if the euro were the dollar or the currency of single indivisible states. The euro is not. Portions of a federal state such as the US might be technically bankrupt, but they are part of the indivisible sovereign whole. Yet that possibility of national bankruptcy is attached to the fortunes of Italy, Greece and the others. It is not clear that the euro will be able to withstand these strains. Could Germany allow these nations to go bust, prop them up, and be "infected" by their debts and crumbling credit ratings?

In most scenarios, currency unions break up only when the strong core backers, not the weak peripheral dependants, walk out and stop paying. For reasons of history, the Germans are unlikely to walk out, just as the Saudis will not now walk out of the monetary union. But some interesting short-term issues might be raised. It may well be that a euro, rather than THE euro, would emerge; a curious currency covering a mix of nations with relatively solid public finances. (It could be called the Deutschmark.)

This new currency might comprise, under German leadership, France, Finland, the Netherlands, Cyprus, Luxembourg, and Slovenia. Countries such as Ireland, Italy, Greece, Spain and the rest would go back to their old currencies, but flexibly pegged to the new euro. These are alarming thoughts to some, but nothing is impossible and they give food for thought for those advocating a unified Gulf currency, especially after the opting out of both Oman and the UAE from the grand plan of GCC monetary union.

Dr Mohamed Ramady is a former banker and visiting associate professor , finance and economics , King Fahd University of Petroleum and Minerals, Dhahran