Gulf Monetary Union still has currency despite Eurozone crisis

A Gulf Monetary Union (GMU) has been in sterile discussions for more than a decade. The Gulf countries first decided on a common currency in 2000 and were hoping to achieve it by 2010 but the Global Financial Crisis and Euro zone crisis threw a wrench in the works. Initially, the GCC countries focused on whether the macroeconomic stability conditions were satisfied by its various members to allow for monetary union and a common currency. Given the invention of the Euro in 1999, it was natural for the GCC to attempt to emulate the European path and adopt the Maastricht technical convergence criteria that guided the European Monetary Union. To be part of the GMU countries should have low inflation rates and interest rates, stable exchange rates, adequate level of foreign exchange reserves, and satisfy fiscal criteria: a government budget deficit to GDP not to exceed 3 percent, and a public debt to GDP ratio below 60 percent.

With their long-standing peg to the U.S. dollar and consequent lack of monetary policy independence, the GCC countries have been in a virtual monetary union. The U.S. peg prevented wide divergences in inflation rates and interest rates. Limited government and high oil prices generated budget surpluses and ensured fiscal stability with low levels of public debt. The major stumbling block on the path to European Monetary Union was averted. But given the Eurozone crisis and potential demise of the Euro does it make sense to forge ahead with the GMU or should these ambitions be thrown into the dustbin of history? The short answer is that it is imperative for the GCC countries to move towards a Gulf Common Market, greater economic and financial integration and the Khaleeji, a common currency.

Lessons from the Eurozone crisis

The GCC economies are more homogenous than the EU before the latter became a reality. Characterised by young, fast-growing populations, including a large highly mobile expatriate workforce, liberal economic policies, the GCC countries share a common cultural heritage, language and political framework. They have common economic policy objectives: diversifying their economies, job creation for nationals and greater energy efficiency.

Clearly there are lessons to be learnt from the Eurozone crisis concerning fiscal stability, but the GCC does not have many of the issues Europe faced. The GCC has enormous foreign exchange reserves of about $1 trillion; exchange rate stability; relatively low interest rates; a low level of debt compared to GDP, low inflation, a history of macro-economic stability, and the cushion of enormous oil and gas natural resource wealth. They have similar economic structures. The GCC do not face Europe’s constraints of different languages, taxation systems, divergent labour productivity growth rates and levels, and varying levels of wealth that meant richer nations needed to subsidise poorer members’ entry. The path towards GCC monetary union has many fewer thorns.

Though the U.S. peg eases the way towards a GMU, a continued peg to the dollar does not serve the economic interests of the region moving forward. The global shift in economic geography towards the dynamic emerging market economies has led to Asian countries –notably China and India- becoming the main trade partners of the GCC. With only 6.9 percent of GCC trade conducted with the U.S. in 2012, the case for a hard dollar peg is weak. The GCC should move to a currency basket that includes appropriate exposure to the euro and include the Chinese Yuan. The next step should be to create the Khaleeji. Given greater linkages with emerging Asian economies, following U.S. exchange rate and monetary policy geared to addressing U.S. economic conditions, implies an inherent policy conflict. The GCC countries need to pursue independent exchange rate & monetary policies directed at dealing with business cycle conditions of the New Silk Road countries, their main trade and investment partners.

Building blocks for Gulf Monetary Union

What needs to be done? What are the building blocks of a successful GMU? The GMU should be part of completing the Gulf Common Market, of deeper economic and financial integration and harmonisation of laws and regulations. The GCC should accelerate the on-going process of regional integration of physical infrastructure (transport, telecommunications, and energy and power networks). The GCC also needs to prioritize the harmonisation of their business and financial legal and regulatory infrastructure. Most critical is to accelerate the development of local capital markets, set the basis for their regulation & integration, and integrate their payment systems. A common currency needs a fully integrated payments infrastructure.

The GCC’s financial sector is presently dominated by banking, with relatively high concentration among domestic players. Debt securities markets are overshadowed by bank credit and, to a lesser extent, equities. It is vital that the region avoids the pitfalls of EMU by creating a local currency regional debt market. The GCC should create deep and liquid financial markets, which can absorb foreign investment flows, thus making boom-bust cycles much less likely; this would enable a means of pricing risk in local currency, which then allows for greater development of financial instruments within the region.

Strategic benefits of the Khaleeji

If the GCC frees up its financial markets, issuers and investors wanting to tap the vast amounts of liquidity available in the Gulf could list their stocks, bonds, Sukuk and other securities in the Gulf’s financial markets. The GCC countries would then be able to manage and control their financial wealth: the real prize of GCC economic, monetary & financial integration. Countries or companies could issue securities denominated in Khaleeji. The GCC would possess real, strategic financial power compared to the current situation where they deploy their financial capital through other countries’ financial markets. We should heed the lessons from the on-going Great Financial Crisis. The GCC countries should build their own financial markets to become an international financial power house and avoid the risks and resulting losses from capital deployed in the mal-governed financial markets of the U.S., UK and Europe.

The GMU could usher in a "new world financial geography" in which the GCC States, who control almost 50 per cent of the world's oil reserves, find a new voice on the world's economic stage. The bottom line remains that the growing international economic and financial openness of the GCC countries requires policy coordination and concerted action within a well-conceived economic policy framework, to avoid the risk of being swept by developments that individual countries do not have the power to resist or control.

In Europe, however, political and institutional integration was more advanced and preceded monetary unification. Regional institutions such as the EU Commission set a framework and culture for effective cooperation among senior national policy makers. The GCC Secretariat does not have the mandate or the power to play a similar policy role. The absence of a similar supranational political and economic policy-making institution in the GCC could undermine the credibility of the GMU, the independence and accountability of the regional central bank that would manage the Khaleeji.

The “Khaleeji”, could be traded internationally, it could become an international reserve asset for Arab and other emerging market economies. Gradually a Khaleeji currency zone could emerge with countries using the Khaleeji for their trade and external payments. That would mean greater monetary independence and financial stability in our region; the GCC would emerge with much greater financial power than they possess today.

At a time when the Arab region is in turmoil and reconstruction efforts could exceed USD 1 trillion, the GCC bloc should seize this ‘defining moment’, this moment of opportunity to take a leadership role, move the region towards greater integration, enabling job creation and leading to more inclusive growth. If the vision is greater political union or integration and a common market, then a common currency is an important building block.

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Dr. Nasser Saidi is the Founder & President of Nasser Saidi & Associates. He is Vice-Chairman of Eureeca Capital, a crowd-funding platform. He was the Chief Economist of the Dubai International Financial Centre from 2006 to September 2012, contributing to build the DIFC and its strategic development, and creating & leading the links with governments, central banks and international financial centers and organizations. He is a member of the IMF’s Regional Advisory Group for MENA, Co-Chair of the Organization of Economic Cooperation and Development’s (OECD) MENA Corporate Governance Working Group. Dr. Saidi served as Minister of Economy and Trade and Minister of Industry of Lebanon (1998-2000) and First Vice-Governor of the Central Bank of Lebanon (1993-2003). In 2012, he was named among the 50 most influential Arabs in the World by The Middle East magazine, for the fourth consecutive year. Twitter: @Nasser_Saidi