The 2005 French and Dutch European Union “No” votes for the proposed European Union constitution is a good opportunity for those in the Gulf Cooperation Council (GCC) to reflect on what they wish to achieve through the planned monetary integration by 2010. The proposed European constitution, which was rejected by the two most pro-European and pro-Union countries, had sought to tie the European Union countries into a stronger bond of economic and political union. It was economic union issues, rather than political, which seemed to have been rejected by the voters.
The introduction of the single currency, the euro, and the so-called alignment of the various European countries economies’ were supposed to bring greater economic benefit to individual citizens as the various EU economies were being integrated. In theory, there was no need to compare prices in different national currencies, and consumers and holidaymakers could immediately compare what the price of an identical commodity was like. Theoretically, if the national economies were harmonized, and inflation was at the same level, and national central banks and governments applied same taxation and public borrowing criteria, then the hypothetical commodity, say, a MacDonald’s burger, should be the same in France, Germany, Italy or Greece.
The reason is that EU countries tried to wriggle out of the tight fiscal and monetary bands in order to stimulate their national economies, reduce unemployment and promote growth. Inflation rates varied in different European countries. Instead of resources, people and services moving from one high cost European country to a lower priced European country, the opposite seemed to have occurred, with some European countries suffering continuing higher levels of unemployment and inflation than others.
The lesson for the GCC is obvious. There must be a clear and transparent definition of what is involved in economic integration of the six GCC countries. Their task should be easier as the GCC countries have a lot of similarity in terms of their economic structure and Gross Domestic Product composition. They are all linked in one way or another to the US dollar. The planned monetary union in 2010 should technically be an easier matter compared to establishing the euro.
But the GCC countries also exhibit differences. Not all GCC countries are overwhelmingly oil based, with Bahrain and Dubai moving toward diversifying their economies to real estate, tourism and financial services. The UAE is experiencing a construction-led boom and inflation levels in the GCC countries vary. Each GCC country has a separate central bank and it is not yet clear whether they will adopt a European Union model of one central bank which is empowered in setting monetary policy for the single euro concerning interest rates, or allow for Gulf national banks to exercise sovereign decision making concerning domestic monetary policy. Each of the GCC countries also runs different levels of national debt and domestic and international borrowing.
As such, how would a unified GCC monetary policy allow for movements outside an officially agreed GCC public sector borrowing band? If the band is set wide enough, it will be counterproductive in conducting a tight monetary and fiscal discipline on individual countries. During the last few years the GCC countries have benefited from a revenue windfall due to higher oil prices. Some like Saudi Arabia, Oman and Bahrain had run domestic debt from internal borrowing.
The high oil prices have enabled the GCC countries to reduce their overall burden of debt repayments and bring the level of debt to Gross Domestic Product to more reasonable levels. The question then arises — what would happen if oil prices ease and the necessity of borrowing rises again for some GCC countries that have larger expenditure needs and larger populations? Would the borrowing band be set as a percentage of the GDP ratio, or would other factors such as population is taken into consideration?
Another question must also be asked — what is the rationale for the proposed unified GCC currency? The launch of the euro had political undertones, with the European Union countries wishing to project their economic and political strength onto the world stage and ensure that the euro acted in the long term as another currency of international reserve.
Will the establishment of the GCC currency introduce a greater level of investment than is currently taking place, with all the GCC currencies basically tied to the dollar? Will the GCC currency be pegged solely against the US dollar or will a basket of currencies be used as the reference peg? Will the pegged rate be within a narrow or wider band, the first causing the currency to be overvalued in times of oil trade surpluses (as the Chinese are now finding out), while the latter inviting speculative pressures in the exchange markets?
The above issues are more important than trying to guess what name the new unified GCC currency will be called, whether the riyal, dinar or dirham. The GCC countries should not be pushed into hasty decisions on monetary union, but adopt a gradualist approach that takes into account GCC interest. Eventually there will be a unified currency given the similarities in economic fundamentals of the GCC. If there is one peg for the GCC currency, it will be that much more difficult to manage the currency against the vagaries of international speculation, should one or more economy of the GCC stray out of established economic bands. The second major argument for a peg of mixed currencies is that this will afford the GCC countries some degree of independence in setting their own monetary policies that suits regional economic inflationary or deflationary conditions, rather than at the discretion of the US Federal Reserve Bank.
If carried out correctly, the unified GCC monetary union could be established on sound footing. Until then, it is important that individual members of the GCC do not carry out any unilateral changes to their dollar peg exchange rates. What can and should happen between now and 2010, is a more invigorated public awareness campaign by the national central banks to educate the public and regional investors on the implication of a single unified currency for freer movement of capital and investment in the GCC, thus making comparative cost analysis easier for inter-GCC investment decisions.
(Dr. Mohamed Ramady is visiting associate professor at Department of Finance and Economics at King Fahd University of Petroleum and Minerals, Dhahran.)