Kuwait’s decision to drop its four-year old peg to the US dollar in favor of a yet unspecified basket of currencies, has taken its Gulf Cooperation Council (GCC) partners by surprise. It reopened the debate on whether the GCC will be able to meet its self-imposed deadline to introduce the unified GCC currency by the end of 2010, and, at the same time it reopened another debate on whether GCC currencies should be fixed or allowed to float more freely.
Kuwait moved from a currency basket in 2003 and agreed to join the others in the GCC in pegging its currency to the dollar in preparation for the 2010 monetary union. In 2003, Kuwait allowed its dinar to trade in a 3.5 percent band around the reference rate of 0.29963 per dollar. It revalued the dinar in May 2006, allowing a 1 percent appreciation against the dollar. The recent sharp fall in the US dollar and weakening US economy, with prospect of a cut in dollar interest rates and a further weakening in the dollar, caused concern for Kuwait. The country’s economy, which is 95 percent dependent on petroleum derived export earnings, has come under increasing pressure form rising inflation brought about by the falling dollar.
The Kuwait Central Bank’s statement following the abandoning of the American greenback, specifically mentioned the core inflationary concerns, which had “negative effects” on the Kuwaiti economy for the last two years. While the goal of the new currency adjustment is to fight inflation, the new Kuwait currency basket reference is still expected to be “dollar heavy”, maybe around 70 percent, according to some economists’ estimates. Kuwait had been expected to revalue its currency, but it was the shock of moving away from the fixed dollar peg that seemed to have caught everyone off guard.
The markets are now full of rumors of the UAE revaluing its currency, and it was not too long ago that Saudi Arabia was also awash with similar rumors concerning the Saudi riyal. Everyone’s concerns were the same — a falling US dollar and rising domestic inflation. Reactions of various GCC central bank officials varied however, on this issue — “under control”, according to the Saudi Arabian Monetary Agency’s governor, “some concern”, according to the UAE’s central bank governor, and muted reaction from Qatar’s central bank.
And so, what prospects for the unified GCC currency by 2010? Oman seems to have put the first official nail in the coffin in meeting the 2010 deadline when it officially announced on May 23, that the Sultanate had decided not to take part in the planned single currency. Apparently, and according to the Omani Central Bank Governor Al-Zidjali, “Oman did not want to restrict (its) monetary and fiscal policies at present ... “Oman, however, left the door open that it might reconsider its decision and join the unified GCC currency at a later date.
Oman’s decision jolted the other GCC members to make their positions known on the fate of the unified currency. Saudi Arabia stated that, “time was running out”, and that, “we need exceptional efforts to achieve monetary union and single currency by 2010”, while the UAE’s central bank governor proclaimed that “monetary union still stands”.
The Qatari Central Bank Governor Sheikh Abdullah Al-Thani insisted that Qatar “will continue to stick to the Gulf monetary union and coordinate with others”, but seemed to have doubts on the 2010 timing when he added that, for him, “while timing has value, it is more important to do it right”.
The Qatari central bank governor is certainly right. Doing “it right” is far more important than being fixated to an arbitrarily set date. Kuwait’s decision to peg against a basket of currencies and to allow a degree of float for its currency has now raised the real possibility that other GCC countries will do the same individually, long before the unified GCC currency comes about. If this was the case, it will make it much easier to agree to a unified GCC currency that is pegged to major currencies rather than just against the dollar. If the GCC countries do this individually, then they will also be spared periodic bouts of currency speculation in the expectations of their currency appreciation, and thus give the GCC countries a greater degree of flexibility to manage imported inflation.
Sticking to entrenched official stated positions is not helpful in this matter, as individual countries might break ranks and catch other GCC members by surprise as Oman and Kuwait have done. Economic policies, and specifically monetary policies, should follow and react to current realities.
The US dollar — the mighty greenback — is taking a battering on the world currency market, and the US administration is not intervening to support it, but allows trade imbalances to sort them out as American exports become cheaper. Currency values were often seen as national “virility symbols”, which had to be defended at all cost, but this was found to be economically costly and unsustainable in the long run.
The current debate on the GCC’s unified currency should once again center on more fundamental questions — what is the rationale for the proposed unified currency? What basket of currencies is to be used as the reference peg? Will the peg be a narrow or wider band, the first causing the currency to be overvalued in times of oil trade surpluses, while the latter inviting speculative pressure? Would domestic borrowing, as a certain percentage of GDP, be a major factor in determining who strays in or out of the unified GCC currency, or would other factors such as population be taken into consideration? How would a unified currency restrict national monetary and fiscal policies? Oman certainly seemed to think that a unified currency will just do that — and it stated that meeting the GCC monetary union criteria may have a negative impact on its development plan.
Whether the GCC unified currency comes about by 2010 or later is not the main issue now. The actions of Oman and Kuwait have brought to the surface fundamental questions of policy implication that need to be addressed and openly debated. For this, if nothing else, one is grateful.
(Dr. Mohamed A. Ramady is visiting associate professor, finance and economics at King Fahd University of Petroleum and Minerals, Dhahran.)