Monetary union in the Gulf

Disunited Arab Emirates

The UAE deals a further blow to hopes of a Middle Eastern Maastricht

FOR two decades the United Arab Emirates (UAE) has supported monetary union in the Gulf. On May 20th it announced it was pulling out of talks but, in typically opaque fashion, gave no reason for the decision. Its withdrawal raises serious questions about the Gulf governments’ ability to overcome old political rifts for the sake of economic and financial integration.

Many a slip ‘twixt cup and lip

Two weeks ago the Gulf rulers, making reference to Maastricht (the Dutch town where the euro was born), decided that the planned central bank would be based in Saudi Arabia. Abu Dhabi appears to have taken this rather personally. A UAE official, interviewed by Reuters, admitted that the decision would weaken the monetary union and said his country would have been the best place for the bank.

No one expected the Gulf states to make rapid progress towards a single currency. The difficulties are legion, not least the problem of generating the political will to defend the central bank against national interests. Indeed, the UAE’s announcement is a reminder of how the region remains hostage to arbitrary decision-making from the top. It came just two days after Dubai summarily demoted its well-regarded finance minister, Nasser al-Sheikh, who had been trying to make the emirate’s debt situation more transparent.

From a purely economic point of view, the region has already overcome some of the hurdles to a single currency, however. The states of the Gulf Co-operation Council—a club of oil-rich monarchies—already peg their currencies to the dollar, except for Kuwait, which uses a dollar-dominated basket of currencies. (The members are Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE; Oman had already withdrawn from the monetary-union project.) So they are accustomed to outsourcing their interest-rate policy.

The economies are also relatively similar in structure, though in the short term they face some difficulties in meeting the convergence criteria they have set themselves, which are loosely based on those of the European Union (EU). Inflation rates vary dramatically and fiscal deficits, which have been absent since the start of the oil boom in 2003, are about to re-emerge in some countries this year.

The fact that most Gulf currencies are already, in effect, pegged to each other means the benefits of union are limited compared with those in the EU. Travellers can already use Qatari riyals in a Saudi supermarket, for instance. However, many in the region’s financial industry say that a single currency would strengthen economic ties and would help banks develop cross-border products and services.

Moreover, Gulf countries might feel more secure about liberalising and eventually floating a Gulf-wide currency, backed by several countries’ reserves. Many economists in the region argue for a more flexible currency system, starting with a Kuwait-style currency basket, so interest rates can reflect the realities of a region with a very different economy from America’s.

Despite the UAE’s move, the monetary union’s remaining backers seem keen to press on. Each of these countries is trying to promote itself as a regional financial centre. Some may quietly exploit the UAE’s pullout as ammunition against Dubai’s claims in this regard.