GCC central bank & monetary union — How realistic?

LONDON, 30 September — The year is 2010. A young Harvard-educated Saudi, Khalid Al-Ibrahim, has just been named the first president of the new Gulf Central Bank (GCB). He is assisted by a board of directors comprising five other members, mostly former central bankers from the individual Gulf Cooperation Council (GCC) states.

Monetary union between the six member states (Saudi Arabia, Kuwait, the UAE, Qatar, Oman and Bahrain); a unified Gulf banking law, and a single currency are all in place. There was some initial reluctance by Qatar and Oman whether they had indeed met the five economic tests they set themselves for joining such a union.

But the volatile oil market, the falling value of the US dollar, to which most of the individual Gulf currencies were hitherto pegged, and continuing tensions in Iraq and Iran, had eventually convinced them that it would be better inside than outside the single union.

In any case, referenda in both countries voted strongly in favor of membership of the union, a result which the rulers would ignore at their peril.

After a heated debate between member states, it was finally decided to call the world’s newest currency zone the Dinarzone as opposed to the other choice, the Riyalzone.

As a GCC customs union looms in 2005, the above scenario is not as far-fetched as it may sound. Politically, a currency union is planned for 2010 — at least that is the ambition. Whether the six Gulf nations have the political will to implement a “Dinarzone” remains a moot point, especially given the lead time (more than two decades) it has taken to finally agree a customs union. And this primarily because the European Union with its Eurozone refused to sign a free trade agreement with the GCC unless a common customs tariff union was in place.

Last week Abdulhadi Shayif, general manager of Saudi Arabia’s National Commercial Bank (NCB) at a regional banking conference, called for unified banking laws and a single regulatory system for the GCC. “I am sure we are moving toward one currency, one market, unified banking laws, and one regulator,” he reportedly told delegates.

From a banker’s point of view, one can understand Shayif’s sentiments. Gulf banking has long missed the boat to come up with one or two truly global banks. They are too small by international standards, and at best can become pan-regional or niche banks (Islamic banks for instance), where they can at least compete with foreign majors, because of the advantages of local knowledge, language, and distribution and branch networks.

According to Shayif, the top 25 GCC banks have total assets of $258.7 billion. This compared with Citigroup alone of $1 trillion, and J.P. Morgan of $693 billion. Not surprisingly, he beseeches GCC bank owners to set aside petty nationalisms, tribalism, family ties, and the odd egos, to achieve this consolidation. Monetary union, in this respect, could facilitate and expedite banking consolidation especially with the barriers to entry gone.

From an economic convergence point of view, monetary and currency union assumes much greater complexity and significance. Will monetary union lead eventually to political union? Is monetary union possible without inevitable political union, as for instance the Conservative right in Britain seem to be arguing in their opposition to the UK joining the euro and abandoning sterling?

There are huge disparities in crucial economic indicators of the GCC states ranging from size of population (with Saudi Arabia by far the largest with a population of 22.7 million people); to budget deficits; current account; inflation rates; GDP per capita; and trade balance. The unemployment rate in the countries vary markedly according to estimates.

One economic plus for monetary and economic convergence is the forecasts for GDP growth, which remains bouyant in all the countries. Others stress the synergies of the GCC economies — largely oil and gas-based; true diversification more a dream than reality; all run by absolute monarchies; demography of population similar — large percentage of young people and still large numbers of expatriates despite the policies of Saudization or Omanization; huge defense expenditures; persistent budget deficits; and similar consumption trends. There are also socio-cultural synergies — a common religion, language and culture.

Proponents of monetary union can be beguiled by a rosy scenario following such a union, but the reality may be much rockier. Economically and politically, Saudi Arabia will inevitably dominate any such union. Will the GCC ruling families, traditionally very particular in preserving the status quo, be prepared to relinquish this bit of vital sovereignty — their currency and the ability to set monetary and fiscal policies?

Assuming that a Gulf Central Bank must set monetary policy, interest rate policy, allocate and control government expenditure, set a course for managing inflation, unemployment and other such economic indicators, will it be allowed to do so independently from political interference? Will a unified Gulf currency still shadow the US dollar or will union tempt it to follow a more independent floating line?

Perhaps I am getting carried away here. It is most likely that the GCC will not follow the euro zone into Dinarzone, tempting as much as it may sound. Monetary union will most probably take much longer as it is in ASEAN (Association of South East Asian Nations), where they do not even have a customs union in place.

Some of the criteria for convergence may seem obvious, but it is those that are not in place that are almost deafening by their silence. The very nature of the systems of the GCC states precludes a development of political culture and institutions.

Gulf development over the last three decades has been characterized by a surfeit of duplication and economic wastage — driven sadly by petty nationalisms, bulging budget surpluses due to the huge rises in oil revenues and an under-developed economic infrastructure unable to absorb all this sudden wealth. In recent years, economic reality has been catching up fast, with persistent budget deficits, unemployment, and even talk of limited income tax the order of the day.

Some countries such as UAE and Bahrain are already contemplating and coming to terms with “futures without oil”.

In many respects the success or failure of operating a customs union will be a crucial indicator whether the future bodes well for monetary union or not.