Last month, the governor of Kuwait’s central bank, Sheikh Salem Abdelaziz al-Sabah, announced that his national currency would no longer be pegged to the US dollar. It was a shock decision that has cast a dark shadow of doubt over the region’s already fading hopes to establish a monetary union by 2010.
Kuwait’s sudden move to put an end to the fixed exchange rate between its dinar and the greenback, a peg which had been in place since 2003, was a case of weighing national interests above regional ones. Inflation in the tiny Gulf state has been rising steadily in the past two years and recently hit 5%, a trend that many attribute largely to the weakness of the dollar and the resulting “imported inflation” effect.
By pegging its dinar to a basket of currencies, Kuwait hopes that price rises will cool off and its central bankers will be able to exert tighter control over interest rates and monetary policy. But in the process it seems to have taken its neighbors rather by surprise, suggesting that the supposedly harmonious road of regional cooperation towards a single currency is somewhat far from the reality.
Obstacle course
Back in December 2005, the six members of the Gulf Cooperation Council (GCC) agreed upon a number of conditions, to which each state would have to comply by 2010. The various criteria included limits on interest rates, inflation, public debt, budget deficit and foreign exchange reserves – the same sort of things that Eurozone countries must adhere to.
Although most of these conditions will probably be met by 2010, largely thanks to oil revenues and sky-high budget surpluses, a substantial litany of other obstacles stand in the way of creating a single currency by then.
Last December, only a year after the criteria were drawn up, Oman said that it would not be in a position to meet the various conditions by 2010 and effectively withdrew from the draft union. It is not entirely clear when or if the Sultanate will rejoin the process, although it seems intent on retaining independent control over its monetary policy.
The remaining five countries, despite sharing characteristics, such as gigantic budget surpluses and low public debt, are still vastly different in most other respects. Inflation rates vary wildly, for example, touching almost 12% in Qatar in 2006 but barely reaching 2% in Saudi Arabia. Some states, for instance Kuwait, are over 95% reliant on oil for government revenues, whereas others, like the UAE, are making solid progress in diversifying away from it.
All this means that the numerous bones of contention surrounding a single currency, such as the potential location of a regional Central Bank, the setting of interest rates and even the name of the new currency, will be prickly issues.
Although Dubai is the most dynamic economy in the region and Bahrain the longest-established financial hub, it is Riyadh that wields the most political and military clout and, therefore, stands out as the most likely setting for an HQ. Deciding who gets to be the money hub, though, will not be easy.
What might well happen in the meantime, even though they are going to great pains to deny it, is that other members of the GCC could follow Kuwait in turning their backs on the declining dollar and allowing their own currencies to appreciate in value.
If that came about, it should in theory help to ease inflation and reduce the cost of imported consumer goods, as well as make life easier for the hundreds of thousands of low- to middle-income expatriate workers in the Gulf, who remit their salaries back home and who, for a while now, have not been getting very many rupees, ringgits or euros for their dollar.
A matter of time
The problem is that unlike Kuwait, which only moved away from a basket of currencies in 2003, most other Gulf states have been tied to the dollar since the early 1980s. Not only would this be a huge sea-change, it would moreover raise questions about the ability of individual central banks to independently manage their own currencies and handle them in a time of crisis.
In the end, and despite all the setbacks and suspicions, a monetary union for the region is probably a matter of time. But as long as the GCC states remain more interested in competing than cooperating, the finish line for a single currency will be a great deal more distant than 2010.
