Is the GCC Monetary Union achievable? And is the UAE vital to its success?

17/12/2009 | by Markaz Analyst Club

That was the question posed to our in-house analysts this week following the enactment of the Gulf Monetary Union agreement by four of the six GCC nations at the 30th Annual GCC Summit which was held in Kuwait this past week. Oman opted out in 2006 while the UAE, the GCC’s second largest economy (and arguably its most diversified), pulled out abruptly in May 2009 in protest of locating the joint central bank in Saudi Arabia. The signing of the agreement paves the way for the creation of a joint monetary council, which, in turn, is a precursor to the formation of a joint Central Bank. The four member states have equal voting rights within the council, which is empowered with deciding on an appropriate peg for the GCC currency in addition to setting various standards which the union must abide by.

Our analysts responded with a resounding “Yes” to the first part of our question and believe that the enactment of the agreement is a de facto sign that the union will come to pass. In fact, Assistant Vice President for Oil & Gas, Mr. Rajiv Bishnoi, countered the initial query with a question of his own: “What is the monetary union likely to achieve?” He notes that most GCC currencies are either pegged to the US Dollar or “a large part, as in case of Kuwait, is pegged to [the greenback]”, thereby limiting monetary policy freedom. “The movement between GCC currencies is pretty limited and there is no hedging required/available among the GCC currencies. GCC currencies are also thinly traded in currency markets.” Consequently, he posits that the “the purported benefits of reduced transaction costs, greater price transparency and enhancing trade, are quite limited.”

The issue of the GCC currency peg, both in technical and political terms, was brought up in the majority of analysts responses. Senior Vice President for Research, Mr. Raghu Mandagolathur, believes that an issue of more importance than the unified status of the currency “is the [US] dollar peg. With the dollar doomed to decline for the foreseeable future, GCC leaders would be very unwise to play the game politically by keeping the peg and paying an extraordinarily high price” for it at a later date.

There are some parallels to be drawn between this endeavor and the experience of the European Union, however, Mr. Bishnoi notes that “some of the benefits (and costs) of the Euro to the European Union is not likely to be replicated in the case of the Gulf; unless bolder (and riskier – political and economic) steps of “real” de-pegging of the common currency from the US Dollar, and the pricing of the main export (hydrocarbons), are taken to establish the new currency as sort of additional “hard” currency for other countries.”

Concurrently, the importance of setting a timeline for the creation of the Union was emphasized by His Highness the Amir of Kuwait, Sheikh Sabah Al-Ahmad Al-Sabah, at the opening ceremony of the GCC Summit, however, it remains to be seen whether such a timeline will be set, and more importantly, adhered to. Senior Research Analyst, Mr. Ramadoss Venkateshwaran, raises the concern that the member states may face difficulty reaching “a common ground” on such technical and political issues like the “determination of initial exchange rates, normalizing of economic parameters, role of the monetary authority etc”, not to mention the issue of the currency peg. However, Mr. Raghu Mandagolathur, going against the grain, is of the opinion that the economic boom of the past decade allowed the GCC nations to be quite lethargic in meeting the original 2010 deadline for the union. However, he states that “in the changed scenario where global events have pushed the region to great challenges, I feel they may now have a more changed and pragmatic position on this very important but ever delayed event. Hence, I feel that a unified GCC currency would be in place soon, much against the street estimate.”

As for the importance of UAE participation in the union, all respondents agreed that the UAE’s status as the GCC’s second largest economy, in addition to its continued goal of becoming the GCC’s financial hub, make it a potential major player in the union. The UAE’s recent debt woes, which many believe are a mere harbinger of more trying times to come, has “moderated [the country’s] bargaining power and, hence, would make it easier to pursuade” it to rejoin the union at a later date (Mr. Ramadoss Venkateshwaran). Given the UAE’s ambitions to be a “trans-shipment hub of the Gulf”, they would likely benefit the most and “may [re]-join the union sooner rather than later” (Mr. Rajiv Bishnoi).

The formidable size of the Saudi economy, in addition to the health and growth potential of smaller economies such as Kuwait and Qatar should provide demand and support of the joint currency. Additionally, UAE’s size and long-term attractiveness to foreign investors would also bring demand, resulting in a more stable and stronger currency (Mr. Bader Asadallah, Assistant Analyst). Given the steady increase in oil prices, with the resultant revenue, the GCC states should take this opportunity to make concrete, meaningful steps towards bringing the monetary union to active fruition in order to strengthen the regions global position as an economic bloc.

So, in closing, the consensus at the Markaz Analyst Club is that while the road to the union might prove to be a winding (and bumpy) one, the GCC will find its way to the end of it, and more likely than not, will pick up its UAE brother at some point along the way.

The Markaz Analysts Club is an initiative launched by Markaz with an aim to collate the many varied and diverse viewpoints of Markaz analysts in an informal setting in order to share with the public the depth and breadth of analyst knowledge power within Markaz. On a periodical basis, a question concerning the topic/s of the day is posed to our analysts spanning various departments within Markaz (from Real Estate to Oil & Gas to Corporate Finance etc), these analysts’ responses are then compiled into a brief opinion piece for public viewing.