High time for a single GCC currency

In terms of appropriateness, as all member states have similar economic structures – export-orientated economies – the single currency should be viable and not be that difficult to implement.

According to monetary theory, key benefits of currency union include the elimination of transaction costs and the generation of greater levels of trade between member states.

 

With regard to these theoretical benefits, reactionary economists argue that, as all six sovereign currencies are pegged to the US dollar, transaction costs are already effectively non-existent.

They also point out that a single currency would not stimulate much new intra-Gulf Cooperation Council trade as most of the region’s trade involves exporting oil and gas to Asia and Europe, not trading goods with one another.

 

“The [Arab] Gulf area will be stronger with a single currency.” J Malik, Italy More comments…

For currency union to be effective, there will need to be a single independent central bank along with a GCC monetary authority.

Fiscal budgetry

These institutions would need to have the authority to set fiscal budgetary restrictions, and require member states to provide timely and transparent data including national accounts.

Many doubt, when push comes to shove, GCC leaders will actually defer to a supranational institution. A federation of existing central bankers would probably lead to a weak currency and increase the likelihood that it will stick with the dollar peg.

 

Much of the potential success or otherwise depends on two things: a strong independent central bank and what exchange rate mechanism the region’s policymakers decide to adopt post 2010.

It seems that at present there is little appetite – at least publicly expressed – to move away from the dollar peg, let alone consider invoicing future oil sales in Gulf dinars.

 

Reasons given for maintaining the status quo include the fact that the dollar is the de facto currency of international trade and that Opec oil sales are invoiced in dollars.

It is also a fact that GCC governments hold vast sums of dollar-denominated assets, such as US Treasury bonds. A move away from the dollar would see more uncertainty as to the value of these assets.

 

However, the dollar peg is not the optimal choice for the region’s economies.

 

As GCC economies mature and attempt to diversify away from dependence on hydrocarbons, the utility of the dollar peg needs to be critically examined.

 

Even if the current arrangement is kept as a convenient convergence tool up until 2010, once launched GCC leaders should seriously consider viable alternatives such as a managed free float or a loose peg to a trade-weighted basket of currencies.

 

Key problem

One key problem with the dollar peg is that it effectively means that GCC central banks have outsourced their decision-making powers on interest rates to Alan Greenspan of the US Federal Reserve.

 

Not having independent monetary policy tools can be problematic, particularly in terms of combating inflation and encouraging growth.

As a consequence decisions on whether or not to cut, hold or hike rates are based on economic conditions in the US and these are not always the most appropriate for the GCC.

 

It is often the case that the US economy will grow robustly when oil prices are low while GCC economies will either experience low levels of growth or stagnation.

 

Conversely when oil prices are high the pace of US growth eventually slows, and US interest rates have been low for several years now in an attempt to stave off recession.

These low interest rates which the GCC central banks have to track, are now exacerbating inflation in the GCC and leading to the overvaluation of some stock-market and real estate-assets.

 

There is also increasing concern over the size of America’s federal debt, which is almost $8 trillion. Its budget deficit this year alone is expected to be $600 billion. In recent years the US economy has been characterised by substantial budgetary deficits. It consistently spends more than it earns.

As a result, the US is becoming more and more dependant on foreign countries willing to hold dollars in their reserve accounts and buy its Treasury bonds.

 

Essentially the US Federal Reserve prints paper – Treasury bonds and dollar bills – and swaps these for commodities such as oil and consumer items such as Chinese household appliances.

 

The weakening dollar has also resulted in GCC imports from Europe becoming more expensive. When launched in 2002 a Saudi riyal was worth €0.29 euros; today it is worth only €0.21 euros.

This means that it has become 32% more expensive for GCC states to import goods from the eurozone, which happens to be the region’s largest import partner. Unlike the US, the eurozone does not run large trade deficits, and the European Central Bank imposes strict limits on government deficits.

 

If GCC states were to start shifting some of their dollar-denominated assets into euro-denominated ones prior to currency union, it would provide a good hedge against the expected downward decline in the dollar.

Even more significantly if, post-currency union, the GCC decided to allow the purchase of oil in euros along with the Gulf dinar and other currencies, they would see their euro assets appreciate massively, as a greater number of oil-importing nations would hold higher levels of euros in reserve and therefore increase its value.

 

Long-term value

Iran’s decision to open an oil and associated derivatives market in March 2006 is interesting, not least because it plans to invoice contracts in euros, not dollars.

It is not likely that many energy traders will leave New York or London and set up shop in Tehran, but Iran’s move does highlight a rising concern over the long-term value of the dollar.

If the dollar continues to decline against the euro, more states will increase the percentage of euros they hold in their reserves because the euro will be a better store of future wealth, and major oil suppliers will prefer to sell at least some of their oil for euros or currencies other than the dollar.

 

A strong, independent, single GCC currency is likely to attract increased levels of foreign direct investment to the region and facilitate the invoicing of some oil and gas sales in Gulf dinars.

Not only would this provide the region with substantially higher seigniorage revenues but it would also result in the Gulf dinar becoming, albeit a minor, reserve currency with a host of associated benefits, especially for the region’s non-oil financial sectors.

The currency could well be viewed by some Arab and Islamic states as a more “acceptable” reserve currency than that of the US dollar.

 

The notion that it would be too difficult to set up a market for invoicing oil sales in any currency other than the dollar is quite frankly ridiculous, and is largely being propagated by those with a vested interest in the current petrodollar hegemony.

[Emilie Rutledge is a British economist who is currently based at the Gulf Research Center in Dubai].

The opinions expressed here are the author’s and do not necessarily reflect the editorial position or have the endorsement of Aljazeera.