The impact of Greece’s debt problems on the euro is good reason for GCC members to proceed with caution as they work towards monetary union. Published in MEED, Issue No 28, 9-15 July 2010
When European officials decided on the symbol for their new currency in the late 1990s, they probably thought the E character, based on the Greek letter epsilon and with two parallel lines to denote stability, was a good fit. But some 11 years after the euro was introduced, and with a flailing Greek economy causing its value to fall sharply on international markets, the choice looks less assured.
For the GCC countries, which missed a target of introducing their own single currency in January, the European currency’s difficulties offer a good excuse for further delays on their own scheme, and also a useful opportunity to reassess the policy.
Perhaps the simplest lesson of all for them to learn is that it pays to be prepared for the worst. “The euro’s problems have highlighted the fact that things can go wrong and that clear rules, monitoring and enforcement are needed to avoid crises,” says Jarmo Kotilaine, chief economist at NCB Capital, the investment subsidiary of Saudi Arabia’s National Commercial Bank. “This crisis is likely to prompt people to think twice and be more careful than they otherwise might have been.”
The euro crisis could not have come at a better time for the GCC, whose members are preparing the legislative framework for a Gulf central bank and monetary union. And even if it forces them to be more cautious, so far it has not deflected them from the task. The GCC Monetary Council, the precursor to a Gulf central bank, insisted after its meeting in Riyadh on 29 March that the project was one of the pillars of economic integration for its members.
The rationale for monetary union has not changed since the idea was first mooted in the early 1980s, when the GCC itself was formed. It offers the opportunity to boost intra-regional trade by eliminating exchange rate risks and simplifying cross-border acquisitions. It also promises to promote greater competitiveness between firms around the region and reduce the overall cost of doing business. But these advantages, while real, are all relatively limited for the four countries due to join in the first wave: Bahrain, Kuwait, Qatar and Saudi Arabia.
All of them have currencies that are either pegged to the dollar or, in the case of Kuwait, to a basket of currencies including the dollar. This means there is already very little exchange rate risk, unlike the situation among free-floating European currencies prior to the introduction of the euro.
Intra-regional trade may not be helped much either. “The structures of the economies are so similar that I don’t know how much you’re going to promote intra-regional trade by adopting the single currency,” says Randa Azar Khoury, chief economist at the National Bank of Kuwait. “Yes, there will be an improvement in trade, but most of these countries are oil-exporting countries [and] they’re not going to be exporting oil or petrochemicals products to each other.”
Given the rather limited nature of benefits on offer, the risks of joining a single currency also need to be low. In 2002, an IMF policy discussion paper, titled ‘On a Common Currency for the GCC Countries’, concluded that “the benefits [of a single currency] do not seem too large, but … neither do the costs”.
The crisis in the eurozone means the Gulf states cannot be quite so sanguine today – they now know what can go wrong and the scale of difficulties when it does.
The biggest downside of a unified currency is that governments lose their ability to use monetary and exchange rate policy to manage their economies. The fact that all the Gulf countries have strong pegs to the dollar means they have already given up much of their monetary independence, but what freedom remains will be further curtailed by the single currency.
For the stronger economies, there is an additional risk of becoming more exposed to the impact of macroeconomic problems in other, weaker member states. In the case of Europe, the weakest member so far has been Greece, which this year had to be bailed out to the tune of E110bn ($135bn) by other European governments and the IMF, after accumulating massive government debts beyond what are allowed in the eurozone’s Stability & Growth Pact.
The Gulf states are in a different situation to the European economies. High oil revenues mean there is little government borrowing, although some places have needed bailouts in recent years, notably Dubai. Even so, the travails of the Greek economy and its knock-on effect on the other members of the euro highlight the need to get the membership criteria right, but also of enforcing the rules after that.
“You need to create a central bank, define its powers and give it the mechanisms needed to exercise those powers,” says Kotlaine.
Although it is now the chief culprit for the euro’s woes, Greece is not alone in having contravened some of the key principles in the Stability & Growth Pact, of keeping government deficits under 3 per cent of gross domestic product (GDP) and overall public debt below 60 per cent of GDP.
“In terms of preparation for monetary union, the emphasis should be on the establishment of a strong institutional, operational and regulatory framework,” says Erwin Nierop, senior adviser at the European Central Bank, which has conducted two feasibility studies on a single currency for the GCC in the past seven years.
“You must also think critically about the necessary level of convergence and you need strong surveillance and enforcement of the convergence criteria. The difficulties we have now in the eurozone go back to how the Stability & Growth Pact was applied by the euro area countries in the past.
In 2007, the GCC agreed its own convergence criteria, encompassing inflation and interest rates, foreign cash reserves, the fiscal deficit and public debt. According to the US-based Institute of International Finance, most criteria have been met. But while the GCC states have been drawing closer together, they still lack the kind of intra-government coordination and transnational bodies seen in Europe for decades before the euro was introduced.
The GCC’s Monetary Council is the key body responsible for laying the foundations for monetary union. In its first two meetings this year, it has discussed issues such as the development of a common statistical framework across the member states and common payment and settlement systems. Such areas are vital to get right, but just as important is the powers that a GCC central bank will have to set or enforce rules and those have not yet been finalised.
The level of integration needs also to go far beyond a unified monetary approach and a powerful central bank. “You also need integration in other parts of your financial markets and fiscal policy,” says Khoury. “Single currencies don’t work if you don’t have fiscal integration. This is what we have seen happen [in Europe]. The fact that every country in the eurozone had its own fiscal policy and revenue pools created problems.”
Whether there is the political will in all the Gulf countries to accept such limits to national sovereignty remains to be seen. Two of the six GCC members have already withdrawn from the project, for the time being at least, and there can be little certainty that others may not follow. As it stands, it is likely to be years before the UAE or Oman decide to reverse their decisions and rejoin the project.
“The currency union will have to have been up and running successfully for several years before Oman would think about it joining again and that doesn’t look like happening anytime soon,” says a Dubai-based economist.
“Implementing the single currency impacts on issues of national sovereignty,” says Christian Koch of the Dubai-based Gulf Research Centre. “The EU stands for union, the GCC stands for cooperation. They are two very different concepts.”
Even if the remaining four countries can sustain the political momentum to continue with a single currency, it could still be many years before any Bahraini or Saudi withdraws such notes from their local bank, whether those notes are called khaleejis, dinars or something else. After the passing of the January deadline, few expect a currency to appear before 2015 at the earliest.
In the meantime there is much to do, including taking major steps like setting up a Gulf central bank and deepening financial market integration. There are also smaller but still important tasks like deciding what the currency should be called, what it will look like, and adapting automated teller machines in the Gulf to be able to accept it.
“You have to be cautious with your timetable, but also transparent,” says Nierop. “You need to have the markets on board and the public at large informed, since they need to prepare themselves in a timely fashion. There are always politically sensitive issues like the name of the currency and the location of the central bank. All these things are sensitive but can be solved. The establishment of the European Central Bank and the subsequent introduction of the euro prove it can be done.”
The euro crisis has certainly provided a useful opportunity to re-evaluate plans for a GCC currency union, but there is still a clear expectation that it is worth pursuing and will go ahead.
“The real issue is with integration,” says Khoury. “What is your objective with the currency union? Your objective is to create a stronger economic bloc. And that means you need to have the freedom of movement of people, goods and capital. A single currency is simply a means to facilitate that. It is a tool towards greater economic integration.”