Almost 10 years ago the idea of a monetary union in the region was the hot topic and it continues to tax the minds of many Gulf state governments. But if the dream is to become a reality, some basic foundation work needs to be put in place.
Many varied paths to one currency
For almost a decade, talk about creating a single currency in the Gulf has remained just that. In 2001, GCC members began debating the plans as a way of achieving greater monetary stability, boosting trade and raising the economic presence of the GCC on the global stage.
Other aims of the union have been to help attract foreign direct investment and lower financial costs through closer integration of financial markets, say economists. But while officials from Abu Dhabi to Riyadh have been forthcoming in announcing dates on when the monetary union may be up and running, progress on the plans has been less apparent. If the original proposals had been followed, this year would have marked the launch of the GCC monetary union, opening the way for the circulation of a single currency across Saudi Arabia, Qatar, Kuwait, Bahrain, the UAE and Oman.
Instead, the plans have been beset by political squabbles over where a GCC central bank should be based, and the withdrawal of Oman and then the UAE from the plans. Last month, however, marked an important step in the realisation of the union with the first official meeting of central bank officials from the four GCC states as part of the monetary council, the forerunner of the union's central bank.
"Priorities have been elsewhere until now," says Tim Fox, the chief economist at Emirates NBD. "With the global financial crisis passed, economies are beginning to stabilise and provided the recovery continues this year, we will see acceleration in pushing this forward." Discussions began at the gathering in the Saudi Arabian capital of Riyadh with the election of Muhammad al Jasser, the governor of the Saudi Arabia Monetary Agency (SAMA), as the first chairman of the monetary council. Rasheed al Maraj, the governor of the Bahraini central bank, was voted in as deputy. Both posts are to be held for a year before re-election.
The next task on the agenda is likely to prove more of a challenge: the complex process of establishing the technical and legal framework for the union under the guidance of the monetary council. "There is a lot of technical work to be done," says John Sfakianakis, the chief economist of Banque Saudi Fransi. "The mundane, technical aspects are the key to making progress rather then the politics." Such work will involve setting criteria for the change to a single currency, such as making sure each state's sovereign debt, budget deficit and inflation level meets minimum standards.
They also need to start pooling economic and financial data on a range of factors including consumer prices and assets and loans in the banking sectors of member states. How to harmonise financial systems, including monetary and fiscal policies on interest rates and co-ordinating labour markets to enable freedom of trade between countries, are other early aspects to consider, say economists. This work will probably come before discussions on the most effective exchange rate regime for the currency. A peg to the US dollar is considered the most likely option for the currency at first. All GCC members except Kuwait peg their currencies to the dollar.
In building the foundations for the union the GCC will, to some extent, be able to draw from the experiences of the formation of the EU. "To bring the regional economies into line is a huge undertaking as the European experience has demonstrated," says Jarmo Kotilaine, the chief economist of NCB Capital, the investment arm of Saudi Arabia's biggest lender by assets, the National Commercial Bank (NCB).
Although the EU was established in 1993, planning for closer integration between European countries can be traced back more than 40 years earlier. Even after the creation in 1994 of the European Monetary Institute (EMI), the organisation established to oversee the transition to the monetary union, it was another eight years before the single currency began circulation in the euro zone. Perhaps the time taken to set up the EU is one reason why GCC policymakers refused to put a schedule to their own single currency plans when they met last month.
Earlier unrealistic deadlines set this year for its establishment, but that has been postponed. Sheikh Mohammad al Sabah al Salem Al Sabah, the Kuwaiti minister of foreign affairs, said in December last year it might take up to 10 years to issue the single currency. "There are virtues in not having a deadline, but there are also risks," says Mr Fox. One such risk, he says, is that progress could stall without a timetable.
In Europe, the EMI successfully stuck to its five-year deadline for the launch of the euro. The most important lesson GCC states could learn from the EU may be how to manage expectations for what a closer economic alliance can achieve. "The risk is to raise expectations of huge economic gains," says Jacques Cailloux, the chief European economist at Royal Bank of Scotland. "In the EU, it was a mistake to present an optimistic view of what the gains of the monetary union will provide."
Mr Cailloux says one of the original aims of the EU in boosting the weight of the region as a trading centre has not been fully realised, with the EU failing to keep pace with Asia in the growth of trade. The global financial crisis brutally exposed the failure of the EU's efforts to create a more stable and closely integrated financial system across borders, Mr Cailloux says. These shortcomings were laid bare by the financial problems now gripping Greece, which has seen its budget deficit swell to 12.9 per cent of GDP last year and prompted fellow EU members to form a support plan.
The GCC has advantages compared with the European model as it is more likely to keep political support from the governments of member states, and the economies of all countries are relatively stable and broadly in line. The peg to the dollar in Saudi Arabia, Bahrain and Qatar means the convergence of exchange rates should prove a less complicated process. But many economists argue that to achieve real credibility the union will need to ensure the UAE, the Gulf's second largest economy, and Oman return to the fold.
The UAE withdrew from the plans last May; Oman in 2007. Sultan al Suwaidi, the Governor of the UAE Central Bank, said last month that the country remained committed to the concept of a single currency in the region, but ensuring free trade was the priority. Mr al Suwaidi had previously attributed the UAE's exit on "fundamental reservations" about the plans, including the absence of a gradual adoption of a unit of account by the monetary union, and the role of the monetary council.
"Not having the UAE and Oman is a big blow to the strength of the currency," says Rory Fyfe, an economist specialising in Saudi Arabia at the UK's Economist Intelligence Unit. "It would make for a much stronger union if they could be persuaded to return." firstname.lastname@example.org