MU delay seen to prompt one-off GCC revaluations

BY ISSAC JOHN (Deputy Business Editor)

11 February 2008

DUBAI — A longer delay in GCC monetary union (MU) will prompt some member countries to contemplate one-off revaluations, while still maintaining the dollar pegs, leading currency analysts warned.

Since the planned monetary union of the GCC in 2010 looks to be an increasingly ambitious goal, there is a rising risk that it will either be delayed or that a few, but not all, of the six GCC member countries will start this union on time, and others will join when they are ready, said Stephen Jen, an analyst at Morgan Stanley, a global financial services firm.

"Modest step revaluations, while retaining dollar pegs, are indeed a possibility, particularly if the Fed continues to ease while oil prices don’t correct significantly. The probability rises the longer the monetary union is postponed," he said.

"A postponement of the launch of the monetary union could complicate the exchange rate policies of the GCC countries. Specifically, the longer the delay, the more tempting/likely it will be for some small open economies in the GCC to contemplate one-off revaluations," Jen said in a report co-authored with Luca Bindelli and Charles St-Arnaud.

Stressing the need for an independent monetary policy with a managed float exchange rate regime for the GCC members, they argued that it would, in theory, be better for the GCC to introduce major changes to their exchange rate and monetary regime after they have introduced a monetary union.

"At the GCC Heads of State Summit in December 2007, the issue of whether to postpone the establishment of the monetary union was tabled for discussion, but no verdict was rendered. Our best guess at this point is that the project will either have to be postponed to 2015 or that only a small subset of the six GCC members will form the initial common currency area, with the others joining in the future, when they are ready. What this means is that the individual countries may have more leeway in devising their own policy paths in the meantime, i.e., it will no longer be essential that the GCC members move in sync and in a coordinated manner," they pointed out.

According to the analysts, the total GDP of the six GCC countries is rather modest. At $790 billion in 2007, the GCC is a little more than half the size of Canada. The total population of the GCC is 36 million, with Saudi Arabia accounting for 24 million of this total.

"While the GCC members have more natural (economic, social, language, historical and cultural) commonalities than the countries in the Euroland, there is relatively less convergence on economic measures." The main concern, they pointed out, is different endowments of natural resources. Second, fiscal convergence will be difficult. With exports of energy being so dominant, swings in oil prices have had, and will continue to have, a major impact on the fiscal positions of these countries.

There is also no more monetary convergence. "The GCC members now need to think hard about their price competitiveness as they enter the monetary union. The longer it takes to form a monetary union, the wider the window for policy interventions to adjust these glide paths."

Another concern is low quality of macro data and a lack of transparency. For example, CPI inflation is available with a six-month lag in Kuwait, while Bahrain and UAE only have annual numbers. In addition, the measures themselves are likely to be understatements of the reality.

Low degree of labour mobility within the region for the expatriate workers is another concern. Though there is effective free movement of the nationals within the GCC, mobility is much lower for the expatriate workers.

"One of the key requirements of an optimal currency area is free mobility of capital and labour, and the GCC has not satisfied this requirement yet," they pointed out.