Dr. Oliver Stonner-Venkatarama, Investment Strategist Emerging Markets for Commerzbank AG provides an insight
The assessment of the current debate about the implementation of a common currency among the member states of the GCC should start with a reflection of the basic idea of a currency union. It is important to emphasise the fact that the main goal of a common currency is to facilitate economic growth and prosperity among the member states. The reasoning is as follows: a common currency fosters economic integration by foreign trade and foreign direct investments due to the reduction of transaction costs. This rationale presupposes that the economic momentum of a specific group of countries is mainly driven by regional economic activities. If this is not the case, other economic measures or structural changes could prove more successful to underpin economic growth. This brings the country-specific, economic costs of a currency union into play. Each member country of a common currency area transfers an important part of its sovereignty to a new monetary institution, the central bank of the currency union. This loss of sovereignty implies less flexibility to steer the economy through cyclical turbulences or structural changes.
In other words, governments have to decide, which currency regime provides adequate stability to support trade and investment flows, on the one hand, and leaves sufficient flexibility to facilitate structural changes or to counteract temporary economic weaknesses, on the other hand.
Oman's need for structural change
Turning to Oman, the reasoning above should be brought in context with the country's need for structural change. There are some striking facts, which underline Oman's special situation among the GCC countries. The oil and gas reserves are estimated to be much less than in most of the other Gulf countries. Only Bahrain appears to be in a similar situation. Therefore, the focus of economic policy is on diversification in order to increase economic growth outside the energy sector; and there is still a lot to be done. Oil accounts for about 68 per cent of total exports. With an export-to-GDP ratio of 60 per cent, Oman's oil dependency is still quite high.
Aside from the future perspective of the energy sector, there is a strong need for decisive government action due to the high unemployment rate. Oman's unemployment rate is estimated to be 18 per cent, which appears similar to Bahrain and Saudi Arabia. In contrast, the UAE, Kuwait and Qatar benefit from much lower unemployment rates in the range of 3 to 5 per cent.
Both these aspects, less oil reserves and high unemployment put pressure on the government not only to strengthen overall economic growth but to accelerate job creation. It follows that particularly growth in the labour-intensive service sector of the economy has to be advanced. This requires acceleration in investment activities outside the energy sector. There is some indication that the economy has already made some progress in this direction. The services-to-GDP ratio has increased from 54 per cent in 2002 to almost 60 per cent last year. The investment-to-GDP ratio has risen from 12.5 per cent to 17 per cent during the same period of time, however this level of investment measured by overall economic activities is still quite low compared to other fast-growing countries. Therefore, the government might aim to improve the investment environment for domestic and foreign corporates. This implies a reliable exchange rate regime, which underpins stability of Oman's trade and investment relations.
With regard to Oman's trade relations there is a further important fact, the four major export destinations, which account for 70 per cent of total exports, and the three main import markets are outside the GCC countries. There is only one exception: the UAE is Oman's main trading partner on the import side. Obviously, Oman's trade relations with countries outside the gulf region are more important than relations within in the region. Particularly trade relations with China and South Korea are growing. This leads to the conclusion that the current peg of the currency to the US dollar might be more beneficial to Oman's economy than a switch to a new regional, GCC currency unit, since foreign trade in Asia is also mainly denominated in US dollar. Furthermore, most of the Asian currencies are closely watched by the central banks with reference to the US dollar. Not surprisingly, Oman's government aims to maintain the US dollar as a stability anchor for the economy. The costs of keeping the currency peg are comparatively low. The currently negative side effects of the fixed GCC currencies to the weaker US dollar are higher inflation rates as well as a loss of purchasing power. This results from the fact that Europe is the major import partner of the GCC countries, and the euro has been quite strong against the US dollar recently.
For Oman, the inflation picture appears less clouded, and the EU import share is smaller than for the other GCC countries. The GCC inflation trends emphasise that the UAE and Qatar have a much stronger incentive to revalue the existing currency peg or to change the currency regime.
Lessons from the euro area
The ongoing debate among the GCC countries about the pros and cons of joining the common currency area sometimes focus on UK's decision to stay out of the currency union as a successful economic strategy. However, it is important not to neglect the different starting positions of UK and the GCC countries. The major arguments for UK to stay out of the euro area for the time being have been differences in the cyclical trends between UK and the other EU countries as well as monetary flexibility in times of economic weakness.
In contrast, the GCC countries already transferred monetary responsibility to the Federal Reserve of the US with the implementation of fixed exchanges rates to the dollar. In other words, the GCC countries did not opt for monetary sovereignty and monetary flexibility. Instead, the first priority has been economic stability due to monetary conditions set by the Fed and a stable exchange rate, which implies less vulnerability of the oil-export dependent economies to external shocks. Beside UK also Denmark, Sweden and Norway decided to maintain monetary flexibility in order to counteract cyclical shocks, if necessary. On the backdrop, of this less uniform picture of the EU and euro area than usually mentioned in the media, Oman's cautiousness in terms of joining a GCC currency union is well underpinned. Structural differences are important for a government's decision about an appropriate exchange rate regime.
Cohesion of the GCC countries
The development of the euro area also provides a clear indication of important pre-conditions for a strong incentive among the GCC countries to join a common currency area. A strong cohesion of the region, induced by growing trade and investment relations provides the best environment for a quick and proper implementation of a common currency. Germany's trade relations with the other European countries account for about two-thirds of the country's total exports and imports. Not surprisingly, Germany has been always a strong supporter of the economic and political integration of Europe. With a longer term perspective, a similar trend could result from efforts of the GCC governments to diversify their economies. If this leads to a strengthening of the domestic, non-energy sectors, this is likely to pave the way for a stronger economic and monetary integration of the GCC countries. All in all, Oman may change its mind regarding its accession to GCC currency area in the not too distant future.
© Banker Middle East 2007
