What will a GCC currency union look like in 2010?

Speaking to the press in Abu Dhabi, UAE central bank governor Sultan bin Nasser Al Suwaidi commented: ‘There is no intention for the time being to un-peg our currencies from the US dollar because if you look at currencies worldwide, you will find that all of them keep fluctuating, rising at some times and declining at others.

‘So the decline in the dollar is a temporary phenomenon and we should not build long-term decisions on short-term issues.’

However, that is exactly the dilemma that GCC central bankers now face with a proposed currency union. Will a long-term currency union be established with a peg to a devaluing US dollar at a time when the Gulf currencies should be appreciating to stop their economies overheating?

Currency union

It would be inappropriate to compound a ‘short-term’ problem by solidly embedding it in a long-term currency union, which will be very difficult to change once in place.

This is perhaps the moment to consider change. Is a dollar-peg in the long-term interests of the five GCC members that have one? Or has renegade Kuwait got it right with a currency basket that allows revaluation to offset imported dollar inflation?

Perhaps then the most appropriate solution for the 2010 currency union would be for the four – Saudi Arabia, the UAE, Bahrain and Qatar – to join Kuwait’s currency basket model, and float a new currency. It would still be dollar-backed, just somewhat less than the 100% of the five’s currencies today.

Saudi Arabia does seem to have ruled this out. And for all the talk about long-term solutions, the UAE does seem to be hoping for a short-term recovery in the US dollar.

Al Suwaidi recalled how the US dollar rose for nearly 10 years before weakening for the past three and a half years. ‘Our hope is that the dollar will rise again,’ he said.

Dollar devaluation

But the economic forces that have put the US currency under such pressure show little sign of abating. The house price falls that triggered the sub-prime crisis seem far from over.

The Federal Reserve is pumping liquidity into the US economy, more of the same monetary inflation that is undermining the value of the US dollar. And when the presidential election is over this autumn the economy could take another downward lurch.

That will take us into 2009, a year away from the promised GCC currency union. It is to be hoped that the authorities are considering a Plan B in case the dollar tumbles in a major crisis, dragging the currencies of the Gulf States down with it.

See also:
GCC common market: boon or bust for Gulf?
Making a success of the GCC common market
Listen: UAE economy has outgrown the dollar peg