Monetary headaches
The goal of a GCC monetary union may be served well if government officials and central banks start considering what a Gulf single-currency might actually serve.

Midas, the king of Phrygia, was once offered his choice of any gift as a reward for pleasing the god Dionysus. Famously, the king chose that anything he touched should turn to gold. As the story goes, it wasn’t long before the king discovered to his cost that great wealth has its downsides.

The central bankers’ of the GCC, meeting on April 6 in Doha, might empathise with Midas. Their long-standing attempts to form a monetary union by 2010 are, they say, still on course. Yet, the wildly varying rates of inflation among GCC members – triggered by booming commodity prices and a slumping dollar – threaten to scupper their timeline.

The GCC’s own Midas touch, oil, is currently trading around the US$110 a barrel mark while gas prices, in which the Gulf is equally well-endowed, have increased by around 35 per cent so far this year. The result is a GCC flush with liquidity, and money supply growth, which in some cases is exceeding 40 per cent a year. As might be expected, this glut of cash is creating inflationary headaches for GCC members. Unfortunately, with the exception of Kuwait, their dollar-pegged currencies are forcing them to adopt a monetary policy precisely the opposite of that which is needed: they are dropping interest rates in line with the US Federal Reserve.

Inflationary pressures
The situation is hitting members with varying degrees of severity. Qatar and the UAE are both experiencing double digit inflation, while year on year figures for Saudi Arabia show inflation there has risen by 1.7 per cent in the past month alone, taking February’s tally to 8.7 per cent. To throw these numbers into relief, five years ago CPI inflation in Qatar was as low as 2.3 per cent and broad money growth only 4.8 per cent.

Adversity is a great bell-weather for organisations like the GCC; it either binds their members closer together, or pushes them further apart. In the case of the proposed GCC single currency, the response to the current monetary migraine does not bode well for the future. First, Oman announced in 2006 that its economy would not be ready to join the single currency by the 2010 deadline. In itself this need not have been a problem (think UK and the euro), yet the following summer Kuwait, typically considered a stalwart of greater GCC integration, switched its dollar peg to a basket of currencies.

This represented – indeed represents – a problem for the monetary union. In a sense, Kuwait merely reverted back to the status quo ante (it had used a currency basket to value its dinar prior to 2003). Yet, maintaining the dollar peg was seen as a key prerequisite of eventual union. By dropping the peg, Kuwait was publicly demonstrating its dissatisfaction with the institutional inertia of the GCC central bankers’ committee.

Since then, the dinar has been able to limit depreciation against a group of 11 major currencies to 23 per cent over a five-year period, compared with 37 per cent for those GCC members who have maintained the peg. It is perhaps too early to say whether the basket has helped curtail inflation in Kuwait, but recently released figures for last December show inflation at 7.54 per cent; high, yes, but significantly lower than that seen in Qatar, the UAE, Oman and Saudi Arabia.

Every month, it seems a new study, investigation or review into the dollar peg and its possible revaluation is announced, only for it to be later confirmed that yes, the peg will remain, and no, there will not for the present be any revaluation. What are their options though? A revaluation against the dollar will lead to a massive loss in external dollar-denominated assets and might possibly push the currency over the edge. Moreover, with less than two years before the single currency is due to come into effect, central bankers want to create as little turbulence as possible. Even a mild revaluation against the dollar will throw a spanner in the works. Hence, at their Doha meeting, the central bankers appeared not only to commit their currencies to the dollar peg at the current rate but also to peg the future single-currency to the dollar.

Looking at options
Currently, the GCC seems to be coasting toward a monetary union few observers believe to be feasible within the given timetable. Rather than glide along on auto-pilot, now might be a good time for government officials and central bankers to start considering what a Gulf single currency might actually be for. The GCC sits on roughly 23 per cent of the world’s oil and gas reserves, and accounts for 1.5 per cent of its GDP. A GCC single currency has the potential to become a significant Forex player in its own right. So why not leave some options on the table?

Option one, the preferred option, will no doubt be to maintain the dollar peg, with perhaps an agreed one-off revaluation when the new currency enters circulation. Option two will be to agree to a coordinated transition to a basket of currencies (and even commodities) along the lines of Kuwait–this will be a good policy to precede an eventual free float of the currency. The third option will be to peg the currency to an alternative: the IMF’s Special Drawing Rights (SDRs), for example. Pegging to the SDR will have the advantage of tying the GCC single currency to a basket, without the potential political headaches of determining its composition.

The ultimate goal though must be a freely floating currency, and this should be sooner, rather than later. A variable exchange rate brings its own risks, but it allows the central bank to set an independent monetary policy that best suits the needs of the wider economy. In the case of the GCC, this will mean no longer being at the mercy of the Fed and having the ability to trim interest rates to match local inflation, growth and employment figures. Current non-monetary measures to beat inflation are perhaps one of the most regressive features of the GCC economies: subsidies are distorting markets, stifling competition and creating feedback loops for further inflation. The sooner the GCC is able to switch from these practices to orthodox monetary measures, the better for everyone.

When they meet again in June, the GCC central bankers will no doubt be faced with the same questions as before. Perhaps, they should remember Midas, who eventually lost his golden touch, passing it on (as the legend goes) to the river Pactolus, which became a source of abundant wealth for future generations of Phrygians. The black gold of the Gulf will one day pass on too; the challenge facing the GCC remains how to make the best use of it now. If the result is a prosperous and developed region, with both political and economic independence, then that truly will be a golden legacy. They will struggle to achieve it though without their own, free, single currency.
 

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