x Abu Dhabi, UAESunday 23 July 2017

Ready or not, the Gulf prepares for single currency in 2010

Gulf central bankers have yet to name the new currency or decide on the location of its primary institution.

With the introduction of a single Gulf currency the dirham will disappear.
With the introduction of a single Gulf currency the dirham will disappear.

When the Gulf's central bankers and finance ministers said goodbye to each other on Sept 17 in the Red Sea port of Jeddah, there were 20 minutes of posing for the camera and smiles all around. It was the 47th such meeting. They agreed to meet next in Muscat in November and headed to the airport. However, some of the smiles were strained, as they had failed to make real progress. They had hoped to deliver some major announcements, such as the name of the new currency and where the central bank would be located. They parted with these decisions unresolved.

"It would be a pity to miss such a historical opportunity," said Nasser Saidi, the chief economist at the Dubai International Financial Centre (DIFC). The GCC monetary union could usher in a "new world financial geography" in which the Gulf states, who control 45 per cent of the world's oil reserves, find a new voice on the world's economic stage. In reality, they returned home to falling stock markets and banking sectors facing a liquidity crunch. Nobody could agree on a concerted plan of action: while the UAE said it would set up a Dh50 billion (US$13.6bn) rescue package to bail out its banks, the Saudis said their main enemy was inflation. Meanwhile, the Kuwaitis were planning to invest in their own stock market in a bid to slow the slide. Observers were wondering what sort of union the Gulf could ever end up with. However, by Thursday last week, most finance ministers and central bank governors were talking with one voice: there would be a bailout for the banks. Even the Saudis said they were willing to help, even though they added that "no banker has asked for the money yet".

Those who think that greater integration in the Gulf is the only way to counter insecurity in the region and bring greater control to economic matters were cheered. A self-imposed deadline for monetary union is set for Jan 1 2010. This is less than 15 months away. And even if they can decide where to locate a central bank and what to call the currency, the big question is this: what sort of economic union do they want? Should it include political union? Will the new money be called the khaleeji - or may be the Gulf dinar?

The only recent model of a successful currency union is the launch of the euro in 2000. It was not without its teething problems or its critics. The European Central Bank (ECB) is based in Frankfurt and its policies shadow those of the Bundesbank, which since Germany's economic problems in the 1930s has always been more scared of inflation than lack of economic growth. This one-size-fits-all interest rate produced widely different results across Europe. While many of those at the periphery prospered, such as Ireland and Spain, their booms have now turned to bust. They had asset inflation for nearly 10 years, with house prices almost doubling in that period. However, Ireland is now in recession, while Spain has more than one million unsold homes and is likely to join them.

Jean-Claude Trichet, the president of the ECB, is the figurehead and talks for the euro in the same way that the financial markets listen to Ben Bernanke, the chairman of the Federal Reserve, when he talks about the dollar. However, for every utterance of Mr Trichet's on how he wants a strong euro, there have been any number of Italian finance ministers complaining that the currency is too high. The Gulf needs to decide if it wants to follow the European model. Some argue that this is the obvious thing to do. Mr Saidi has advocated creating a European-style banking executive, saying that "the solution we feel markets (and possibly the public) would find more credible and suitable" would be one modelled on the ECB.

"The GCB [Gulf Central Bank] should be a fully fledged institution with its own budget, a headquarters... and its permanent staff under the authority of an executive board formed by three members: the president, the vice president, and the chief economist," Mr Saidi wrote in a report. Others object that since Saudi Arabia is no Germany and Kuwait's economy nothing like France's, the GCC monetary union should come up with a more home-grown solution.

"You cannot just copy and paste any model from around the world. Not the North American model, not the European model, not the Asian model," said Walid el Hayeck, the director of asset management at The National Investor. "The solution for the Gulf has to be something that comes out of this region and is adapted to its needs and particularities." Choosing a single governor will be politically significant, since every GCC state will undoubtedly want to appoint their own leading economist to the position. A more politically acceptable, but perhaps less effective, option would be to create a council of central bank governors from each of the member states, to meet periodically to decide on Gulf monetary policy.

Advocates say such a solution would also have the advantage of not requiring GCC leaders to choose a static location for the nerve centre of the Gulf monetary union. Instead, the council's meeting could rotate between the six GCC states, and thereby avoid having any one city as the Gulf economic capital. According to Daniel Kaye, a senior economist at the National Bank of Kuwait, deciding on the location may be one of the thorniest issues facing GCC leaders. Nearly every country can make a reasonable claim as the GCC financial capital: Bahrain and Kuwait are two of the region's longest-established finance centres; Dubai has the highest-profile international business hub; Qatar is rapidly creating an advanced financial infrastructure and Abu Dhabi has the money.

However, Mr Kaye argues that following European precedent would require GCC leaders to pick Saudi Arabia over the rest. Saudi Arabia's economy, like Germany's, is the largest in the union and it is therefore "the country likely to contribute the most to the project financially", he says. Some analysts worry that short-sighted squabbling over relatively minor matters, such as the location of the GCB, could derail the monetary union project: GCC countries lack the Europeans' willingness to make individual sacrifices for the sake of the whole, they say. "A sense of urgency is notably lacking," said Mr Saidi. "The passive attitude needs to shift dramatically for the project to see the light of day."

Oman already jeopardised the monetary union when it unilaterally withdrew from the plan in January last year. Four months later, Kuwait broke with the remaining five GCC countries when it chose to depeg its currency from the dollar. "The single-currency project does not appear to be backed by any drive towards union at a political level, perhaps robbing the project of a permanent source of momentum," according to Mr Kaye.

High inflation rates also stand as a serious obstacle to achieving monetary union, Mr Saidi said. Originally, the six GCC-member countries agreed that "inflation rates should not exceed the GCC-weighted average inflation rates plus two per cent in each member country". This has become increasingly impractical, as inflation rates soar in some GCC countries and remain relatively flat in others. Qatar's inflation for the second quarter of this year hit 16.8 per cent, while Bahrain's registered a mere 3.3 per cent last month.

However, despite inflation problems, some analysts are optimistic about the prospects for the GCC monetary union. There are even some who maintain that so long as the political will is there, nearly anything is possible - including meeting the original deadline. Paul Gamble, a senior economist at Jadwa Investments, thinks there are significant forces acting in the GCC's favour. "In Europe, you had a collection of countries with different economies, and very different needs when it came to monetary policy," he said. Countries such as Ireland, Spain and Portugal were clearly overheating, and required a higher interest-rate policy than countries such as Germany and France. In the GCC, all of the member countries require a similar monetary policy - one to help them tackle inflation." Mr Gamble also notes that since most GCC economies rely heavily on oil, their needs are likely to stay aligned for some time.

Other factors also work in the GCC's favour when it comes to forming a monetary union. The scale of the project in the GCC is much more manageable than it was in the EU: when the EU was forming a monetary union, its combined GDP amounted to around US$10 trillion (Dh36.7tn) in today's prices. In contrast, the combined GDP of the entire GCC is likely to be less than $1tn this year by most estimates.

Additionally, GCC countries' exchange rates have been effectively frozen for years, ever since they pegged to the dollar. In the EU, deciding when to freeze exchange rates between the member countries was one of the most difficult steps in the process of phasing in a common currency. The GCC also shares a common language, common demographic trends and a common reliance on expatriate labour, all of which are likely to smooth the transition towards a unified economy.

Most analysts agree that the GCC will eventually achieve a monetary union, despite difficulties, because the advantages of doing so are simply too great to pass up. @Email:tpantin@thenational.ae