The Gulf: No common currency on the horizon Print
Written by Marios Maratheftis at Standard Chartered   
Monday, 09 November 2009 16:33


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The Gulf Cooperation Council (GCC) countries had aimed to introduce the GCC common currency in 2010, but this now looks very unlikely. The UAE did not welcome the decision to locate the central bank in Saudi Arabia, and its subsequent decision not to participate in the monetary union (MU) should not have been a surprise.

Theoretically, introducing a common currency solves two problems.

  • First, it makes any peg more credible by making it irreversible, and makes it impossible for countries to engage in competitive devaluations (as Greece and Italy did before the introduction of the euro).

That said, this has never been a problem in the GCC.

  • Second, a common currency eliminates FX risk in the common currency area and reduces transaction costs, thereby encouraging intra-regional trade.

However, given that the GCC economy is dominated by hydrocarbons and services (mostly in non-tradeable sectors such as real estate), intra-regional trade would be unlikely to increase, even with a common currency.

The idea of having a common currency in the GCC is driven more by politics than economics.

Three conditions would need to be met in order to clear the way for the successful introduction of a GCC common currency in the near future.

  • First, it needs to be a GCC currency, with all six member states participating rather than four.

The GCC needs to find a compromise to induce the UAE and Oman to rejoin.

To make this happen, the GCC should perhaps negotiate all issues at once rather than one at a time (i.e., just the location of the central bank). This would make it easier for GCC countries to engage in a give-and-take bargaining process, reaching a holistic solution.

  • Second, the central bank needs to have a clear mandate and room to pursue a more independent monetary policy.

This implies that the common currency should not be pegged to just one currency. If all GCC currencies are pegged to the USD and the common currency is also pegged to the USD, then the common currency will bring no change from the current situation. Also, it is important for all member states to have equal (rather than weighted) voting rights in the central bank so that decision-making is not dominated by just one country. This could be among the concerns of smaller countries in the region.

  • Third, the region needs to develop deeper debt capital markets.

A more flexible GCC common currency has the potential to become one of the world’s reserve currencies.

Central banks of oil-importing countries could choose to hold a small percentage of their reserves in the GCC currency as a natural hedge against rising oil prices.

But for this to happen, the region needs to develop deeper debt capital markets and domestic currency assets.

Pricing oil versus a basket of currencies


There is also the view that GCC countries should price oil against a basket of currencies and not in USD. We believe this is very unlikely.

There are three main reasons for this.

Opposition to pricing oil in USD in countries such as Iran and Venezuela is politically rather than economically driven. It is worth noting, however, that diplomatic relations between GCC states and the US are very strong, and that the US remains very influential in the region.

   1. Oil prices tend to adjust to reflect changes in the value of the USD, and there are therefore few benefits of pricing oil in any other currency.

   2. Such a decision would have negative implications for the value of the USD and hence for the USD assets GCC countries hold.

   3. The USD is still the most liquid currency and the world’s reserve currency, and it provides the simplest and most transparent way of pricing oil.

The prospect of reforming the pegs


One should differentiate between the GCC countries de-pegging their currencies from the USD and adopting more independent monetary policies. Historically, GCC countries have faced inflationary pressures when the USD is too weak and deflationary pressures when the USD is too strong.

In 2009, as the GCC business cycle has turned down and asset prices have undergone violent corrections (real estate prices in Dubai are down by approximately 50-60% from their 2008 highs), the weak USD and the low US interest rates are appropriate for the region. But this is simply a coincidence.

GCC countries are likely to experience inflationary pressures before the US does, and monetary policy is constrained by the absence of deep debt capital markets and by the USD peg.  

We believe that there would be benefits of de-pegging GCC currencies from the USD and following more independent monetary policies. This, however, does not seem to be on policy makers’ agendas right now. Also, countries are better off changing their FX regimes from a position of strength. Further, even though GCC economies have bottomed out and we expect them to rebound in 2010, the recovery remains fragile.
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