Comment: Flexibility before currency union
By Marios Maratheftis
Published: August 4 2010 17:09 | Last updated: August 4 2010 17:09
In their different ways, China and the European Union have much to teach the Gulf Co-operation Council countries. But, when it comes to currencies, China is the example to follow and Europe the one to avoid.
While currency reform is not on the agenda, a gradual introduction of flexibility into GCC currency regimes is desirable since it would allow some control over monetary policy. Because of the dollar pegs adopted by five of the six GCC states, monetary policy is entirely dependent on the US.
What is on the agenda is currency union. But flexibility makes better economic sense.
Recent events in the EU highlight the limitations of a monetary union. Asymmetric shocks and the absence of a common fiscal system can, and will, lead to problems. The EU has been developing supranational institutions for more than 40 years. Yet the problems of Greece – and market concerns over other indebted countries, such as Spain, Portugal, Italy and Ireland – show that without a common fiscal system and, ultimately, political union, monetary unity faces big limitations.
The GCC lacks even basic supranational institutions. As a result, the initial 2010 deadline for the introduction of the GCC common currency has been missed. At their spring meeting, GCC central bank governors agreed there was no need for a new deadline. The real question is whether there is any need for a common currency at all.
Advocates argue that a common currency can encourage intraregional trade by eliminating currency risk and reducing transaction costs. A unified currency can also make pegs credible by making them irreversible, reducing the likelihood of speculative attacks.
These two advantages were important for Europe. But they are not relevant to the GCC.
Intraregional trade is less than 6 per cent of the GCC’s total trade. This is not because of currency risk – GCC currencies are pegged to the dollar and, by default, to each other. This is because more than 90 per cent of GCC exports are hydrocarbons. As long as these economies are dominated by the hydrocarbon sector, intraregional trade will remain low, with or without a common currency.
The US dollar peg has come under pressure in recent years. This was because the region needed tighter monetary policy to control inflation, especially asset price inflation, at a time when the US Federal Reserve was reducing rates. But it is important to note that there was never any pressure on the de facto pegs of GCC currencies with each other. It was the dollar peg that was questioned, not the parity between the Saudi riyal and the UAE dirham for example. As a result, the second advantage of a common currency is also irrelevant for the GCC.
For China, the decision to introduce more flexibility in the renminbi made good economic sense. The nation is moving to more sustainable growth driven by domestic demand. Gradualism is critical. Any appreciation in the renminbi is likely to be slow.
The GCC states would benefit from more flexibility. Throughout the history of their currency pegs, they have faced inflationary pressures when the dollar has been too weak and deflationary pressures when the dollar has been too strong.
One should not underestimate the role politics plays. China faced pressure from the US and the EU to allow its currency to strengthen. Timing the de-pegging of the renminbi before the G20 meeting was not a coincidence. The decision is likely to ease any pressures China might have faced.
But when it comes to the GCC, there is no political pressure to move away from the pegs. GCC hydrocarbons are priced in dollars. Any move in domestic currencies has a limited impact on competitiveness.
No one has, therefore, argued that weak GCC currencies give the region an unfair advantage. Consequently, the GCC has never been subject to the same pressures from trading partners to revalue or to de-peg.
If a GCC common currency comes into existence and enjoys more flexibility than the national currencies currently do, that would be a step forward.
What is important, however, is flexibility. The problem is that a GCC common currency is neither necessary nor sufficient to achieve this.
Marios Maratheftis is regional head of research, Middle East, North Africa and Pakistan, at Standard Chartered Bank
