The collapse of the single currency?
Hamad Saud Al-Sayari slams his official GCC monetary union papers down on the table, rises and prepares to leave the boardroom. This meeting is over. But while other GCC central bankers rise to follow Saudi Arabia's central bank governor, a large proportion remain seated, or, when half standing, decide to slump back heavily into their leather upholstered chairs despondent at the day's outcome. Significant agreement over the Gulf single currency has failed once again, and the 2010 deadline appears increasingly untenable. What's more, this time things look ominously, and rather depressingly, more permanent.
"They have some major issues to deal with and many of them can't see any solution coming soon," an insider who attended the meeting told Arabian Business as he left the Riyadh summit last weekend.
Sadly, over the last six months to a year the 2010 GCC common currency has looked increasingly doomed. The severe weakness of the US dollar and rising inflation levels have made the shortcomings in existing foreign exchange regimes increasingly apparent. The US dollar is at a 26-year low against the British pound; a global credit crunch has sent US and European stocks plummeting to modern-day lows with large investment banks and mortgage brokers feeling the pinch more than most; ratings agencies potentially face being investigated for a conflict of interest; and the dirham in the UAE, for example, reached new highs last week against its sliding peg, sending the cost of living in the Emirates spiralling. Bids for dirham firmed at 3.6718 per dollar, the highest level since July 26 - the day after Kuwait allowed the dinar to appreciate to an 18-year high against the weak dollar. Things couldn't be worse.
So it wasn't surprising that central bankers of Saudi Arabia, Kuwait and four other oil producers cited "exceptional economic developments" as the reason the 2010 deadline for a monetary union project would be "difficult to meet".
Local investment bank EFG-Hermes was as unsurprised as any organisation within the local finance community. Once the meeting was over it immediately drafted a report entitled Monetary Union Even More Distant, which set out several key points on the economics behind the fiscal failure.
Its author, analyst Monica Malik, says EFG knew exactly what the outcome of the meeting would be even before the bankers convened.
"There were limited expectations ahead of the GCC Central Bank governors meeting that any important decisions would be taken, bringing the planned 2010 monetary union back on track." Malik even goes so far as to say that EFG believed that there was "little to no chance" that the monetary union deadline could be met.
"Following the meeting, our reservations over the union and the deadline have increased, owing to comments made regarding inflation policy," she adds.
Several Gulf governments remain stubbornly fixed to their currency pegs. Last week the UAE and Qatar reiterated their adamant stance on maintaining the dollar peg and rejecting any move towards a basket of currencies and boldly suggested that they expect rising inflation, fuelled by the soaring cost of accommodation in both countries, to decline. Confident, considering the incessant rise of inflation.
Qatar's Central Bank governor HH Sheikh Abdullah bin Saud Al-Thani said his country had no plans to depeg its riyal from the weakest greenback in a quarter of a century, and that measures to control rent rises and other prices would "reduce" inflation. "We are committed to the peg and also to the march of the GCC countries towards monetary union," Sheikh Abdullah said.
"We are taking measures to control prices and rents which would lead to a gradual decrease in inflation."
UAE Central Bank governor Sultan Nasser Al-Suweidi also defended his decision not to ditch the dollar. "I have always defended the peg to the US dollar because all the basic facts that determine the peg of a currency to another are in favour of the US dollar." Inflation in the UAE, which hit a 19-year high of 9.3% last year, has already started to decline, Al-Suweidi pointed out.
And there lies the sticking, rather than the tipping point of the entire common currency debate - every Gulf country has different inflation policies and unless some form of harmonisation begins to be discussed, let alone applied, progress will never be made, suggest experts.
The EFG report adds that rather than having a common approach to inflationary policies, GCC countries in fact decided to "develop different policies to tackle rising inflation".
Al-Sayari noted, however, that each member state would examine the possible options as there are different inflation levels across the region, while the EFG report went on to say that this statement was likely to refer to "interest rate policy, rather than exchange rate policy", especially as the market is increasingly pricing in a potential interest rate cut by the US Federal Reserve on September 18.
"The build-up in inflationary pressure is a key area of disagreement among the Gulf countries with regards to policy and convergence criteria," said the report. EFG-Hermes highlighted in its research that it believed that Saudi Arabia was unlikely to follow a US rate cut in the second half of 2007. "Although the GCC-US dollar pegs generally mean regional interest rates follow that of the US, there is some flexibility and in 2006 Saudi rate movements fell out of sync with the US," it added.
The UAE's Central Bank governor Al-Suweidi, however, said that the UAE would cut interest rates "accordingly" should the US Fed decide to lower rates this Tuesday.
This should test the UAE's commitment to a currency peg, but once again differing approaches to monetary policy are the main obstacle to decisive progress and to meeting the original deadline that is now only two years and three months away.
Malik's report suggests that apart from short-term interest rate policies, the decision to develop different inflation policies is "significant". She says that in preparation for the common currency, countries should be harmonising their monetary policies, including responses to inflation. She adds that although inflation levels are different, the drivers of inflation are similar including rising rents, imported inflation and strong liquidity.
"We have been highlighting that key decisions need to be made, include defining monetary policy, developing uniform monetary instruments and developing institutional frameworks. However, this move to focus individually on inflation goes against formulating combined policy and the union itself," Malik says.
So different are the approaches to monetary strategy that delays to the common currency are likely to result in Gulf nations pursuing more "independent" monetary policy in the medium term, including currency reform, according to EFG's Malik. In other words they are increasingly drifting apart rather than working together towards a common goal that could arguably benefit everyone involved.
"Speculation of currency reform in the GCC or a possible appreciation of the local currencies against the US dollar, particularly the UAE, is likely to increase again following last week's meeting," said the report.
"The UAE still remains the most likely country to move to a more flexible currency regime, although we do not forecast this in 2007. With the US dollar structurally weak and the US economy generally facing a different economic cycle, GCC countries will increasingly focus on the benefits of currency reform. However, we believe that GCC countries will not jeopardise currency stability and any currency reform would involve a move to a currency basket like Kuwait, which would allow greater monetary flexibility and the ability to counterbalance any US dollar weakness."
So the GCC states are playing safe, waiting to see how the dollar plays out and whether it can regain its momentum. Many analysts certainly predict a recovery but in the short-term, so where does this leave the GCC common currency?
One analyst compared its current state to six men running up the Gulf's largest sand dune and not even reaching the mid-point, constantly sliding down as they attempt to reach the top. EFG-Hermes, however, believes there are only "limited direct benefits to a monetary union" given the similar nature of trade among the countries and that a lack of progress will "not have a detrimental effect".
"The main benefit of the common currency was seen to be strengthening monetary policy and as a first step to greater currency flexibility. With increasing signs of individual monetary policy in the region, it is vital for the GCC countries to develop their monetary capabilities to increase their policy tools."
Each of the GCC countries needs to sort out its own individual monetary policies before fixing its attentions on a wider, common currency by the now almost impossible deadline of 2010. It could still be many years before any of us has the chance to use any ‘Gulfos'. Source
"They have some major issues to deal with and many of them can't see any solution coming soon," an insider who attended the meeting told Arabian Business as he left the Riyadh summit last weekend.
Sadly, over the last six months to a year the 2010 GCC common currency has looked increasingly doomed. The severe weakness of the US dollar and rising inflation levels have made the shortcomings in existing foreign exchange regimes increasingly apparent. The US dollar is at a 26-year low against the British pound; a global credit crunch has sent US and European stocks plummeting to modern-day lows with large investment banks and mortgage brokers feeling the pinch more than most; ratings agencies potentially face being investigated for a conflict of interest; and the dirham in the UAE, for example, reached new highs last week against its sliding peg, sending the cost of living in the Emirates spiralling. Bids for dirham firmed at 3.6718 per dollar, the highest level since July 26 - the day after Kuwait allowed the dinar to appreciate to an 18-year high against the weak dollar. Things couldn't be worse.
So it wasn't surprising that central bankers of Saudi Arabia, Kuwait and four other oil producers cited "exceptional economic developments" as the reason the 2010 deadline for a monetary union project would be "difficult to meet".
Local investment bank EFG-Hermes was as unsurprised as any organisation within the local finance community. Once the meeting was over it immediately drafted a report entitled Monetary Union Even More Distant, which set out several key points on the economics behind the fiscal failure.
Its author, analyst Monica Malik, says EFG knew exactly what the outcome of the meeting would be even before the bankers convened.
"There were limited expectations ahead of the GCC Central Bank governors meeting that any important decisions would be taken, bringing the planned 2010 monetary union back on track." Malik even goes so far as to say that EFG believed that there was "little to no chance" that the monetary union deadline could be met.
"Following the meeting, our reservations over the union and the deadline have increased, owing to comments made regarding inflation policy," she adds.
Several Gulf governments remain stubbornly fixed to their currency pegs. Last week the UAE and Qatar reiterated their adamant stance on maintaining the dollar peg and rejecting any move towards a basket of currencies and boldly suggested that they expect rising inflation, fuelled by the soaring cost of accommodation in both countries, to decline. Confident, considering the incessant rise of inflation.
Qatar's Central Bank governor HH Sheikh Abdullah bin Saud Al-Thani said his country had no plans to depeg its riyal from the weakest greenback in a quarter of a century, and that measures to control rent rises and other prices would "reduce" inflation. "We are committed to the peg and also to the march of the GCC countries towards monetary union," Sheikh Abdullah said.
"We are taking measures to control prices and rents which would lead to a gradual decrease in inflation."
UAE Central Bank governor Sultan Nasser Al-Suweidi also defended his decision not to ditch the dollar. "I have always defended the peg to the US dollar because all the basic facts that determine the peg of a currency to another are in favour of the US dollar." Inflation in the UAE, which hit a 19-year high of 9.3% last year, has already started to decline, Al-Suweidi pointed out.
And there lies the sticking, rather than the tipping point of the entire common currency debate - every Gulf country has different inflation policies and unless some form of harmonisation begins to be discussed, let alone applied, progress will never be made, suggest experts.
The EFG report adds that rather than having a common approach to inflationary policies, GCC countries in fact decided to "develop different policies to tackle rising inflation".
Al-Sayari noted, however, that each member state would examine the possible options as there are different inflation levels across the region, while the EFG report went on to say that this statement was likely to refer to "interest rate policy, rather than exchange rate policy", especially as the market is increasingly pricing in a potential interest rate cut by the US Federal Reserve on September 18.
"The build-up in inflationary pressure is a key area of disagreement among the Gulf countries with regards to policy and convergence criteria," said the report. EFG-Hermes highlighted in its research that it believed that Saudi Arabia was unlikely to follow a US rate cut in the second half of 2007. "Although the GCC-US dollar pegs generally mean regional interest rates follow that of the US, there is some flexibility and in 2006 Saudi rate movements fell out of sync with the US," it added.
The UAE's Central Bank governor Al-Suweidi, however, said that the UAE would cut interest rates "accordingly" should the US Fed decide to lower rates this Tuesday.
This should test the UAE's commitment to a currency peg, but once again differing approaches to monetary policy are the main obstacle to decisive progress and to meeting the original deadline that is now only two years and three months away.
Malik's report suggests that apart from short-term interest rate policies, the decision to develop different inflation policies is "significant". She says that in preparation for the common currency, countries should be harmonising their monetary policies, including responses to inflation. She adds that although inflation levels are different, the drivers of inflation are similar including rising rents, imported inflation and strong liquidity.
"We have been highlighting that key decisions need to be made, include defining monetary policy, developing uniform monetary instruments and developing institutional frameworks. However, this move to focus individually on inflation goes against formulating combined policy and the union itself," Malik says.
So different are the approaches to monetary strategy that delays to the common currency are likely to result in Gulf nations pursuing more "independent" monetary policy in the medium term, including currency reform, according to EFG's Malik. In other words they are increasingly drifting apart rather than working together towards a common goal that could arguably benefit everyone involved.
"Speculation of currency reform in the GCC or a possible appreciation of the local currencies against the US dollar, particularly the UAE, is likely to increase again following last week's meeting," said the report.
"The UAE still remains the most likely country to move to a more flexible currency regime, although we do not forecast this in 2007. With the US dollar structurally weak and the US economy generally facing a different economic cycle, GCC countries will increasingly focus on the benefits of currency reform. However, we believe that GCC countries will not jeopardise currency stability and any currency reform would involve a move to a currency basket like Kuwait, which would allow greater monetary flexibility and the ability to counterbalance any US dollar weakness."
So the GCC states are playing safe, waiting to see how the dollar plays out and whether it can regain its momentum. Many analysts certainly predict a recovery but in the short-term, so where does this leave the GCC common currency?
One analyst compared its current state to six men running up the Gulf's largest sand dune and not even reaching the mid-point, constantly sliding down as they attempt to reach the top. EFG-Hermes, however, believes there are only "limited direct benefits to a monetary union" given the similar nature of trade among the countries and that a lack of progress will "not have a detrimental effect".
"The main benefit of the common currency was seen to be strengthening monetary policy and as a first step to greater currency flexibility. With increasing signs of individual monetary policy in the region, it is vital for the GCC countries to develop their monetary capabilities to increase their policy tools."
Each of the GCC countries needs to sort out its own individual monetary policies before fixing its attentions on a wider, common currency by the now almost impossible deadline of 2010. It could still be many years before any of us has the chance to use any ‘Gulfos'. Source
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