UAE Should Rejoin The GCC Monetary Union
By Shawkat Hammoudeh
Dr Hammoudeh is Professor of Economics and International Business at Drexel University. He can be reached at hammousm@drexel.edu.
The Gulf Cooperation Council (GCC) is about 28 years old. It was established in 1981 in response to perceived increasing political risks in the Gulf region in the aftermath of the 1979 Iranian revolution and the 1981 Iraq-Iran war. Therefore, the motivation behind the establishment of the GCC is due to politics more than economics. The growth of GCC has been slow in most of those years, with occasional spurts taking place during short periods. Again, this slow growth has been underpinned by the reasons behind the motivation.
Saudi Arabia has justifiably dominated the GCC due to its larger population, wider geographic area and more enormous resources. On the other hand, the other member countries wanted the political protection of a ‘big brother’ which they found in Saudi Arabia. More recently, things have changed. Some GCC members have witnessed significant increases in their population, accumulated large wealth and built more stable and advanced institutions. They feel that they do not need the big brother’s protection. Instead, they need to be treated as equal partners.
One of those countries is the UAE which has now about 5mn inhabitants, one of the largest sovereign wealth funds in the world, an advanced financial system and a more diversified economy than Saudi Arabia. The UAE is the second largest economy in the GCC and the Middle East after Saudi Arabia. It wishes to be treated as a partner almost equal to Saudi Arabia in the GCC. It has been a founding member of GCC and it hosted the first GCC conference in 1981.
The UAE’s recent withdrawal from the GCC Monetary Union (MEES, 25 May) surprised most people, including those who do not admit it. During the heads of states’ dinner banquet, which was held as a consultative event to discuss the location of the anticipated GCC central bank, the other GCC members supported Saudi Arabia over UAE as the permanent place for the central bank. The UAE showed strong reservations on this decision. Then the big surprise came few days later when UAE announced its decision to withdraw from the monetary union, despite the fact that it signed all the GCC agreements.
While the withdrawal announcement was a surprise to most people, the reasons behind it should not be so. There have an accumulation of events that occurred over the years that increased uneasiness between the two largest economies in the GCC and the Middle East. The GCC has more than 20 institutions: almost all are located in the big brother, Saudi Arabia. The UAE feels that it should host several of those institutions. There are differences on the importance of the unified currency to perform its three basic functions and on the role of the GCC Monetary Council in conducting monetary policy. It seems to me that, in a layman's language, the differences imply that the UAE wishes to have a more powerful central bank, while Saudi Arabia would prefer to leave more room for sovereignty in conducting national monetary policy. There are also border disputes over oil fields and the UAE believes it should have a larger share of those fields. There are most likely other reasons for the tension between those countries that I am not aware of, being far away from the region for many years. The UAE applied to host the GCC central bank in 2004. It was the only country that applied. It feels it has a more advanced financial system than Saudi Arabia does and it sees itself more open and more integrated with the outside world than the big brother. On the other hand, Saudi Arabia is more recognized internationally, a member of G-20 and a highly respected member of the IMF. It has the largest oil reserves in the world and is the largest oil exporter.
However, if we take a parallel with the European Union, most of the institutions are in Belgium and not in Germany or France. But the GCC is not the EU. There are not great economic benefits that can be realized from having a GCC, and those benefits may not outweigh losing sovereignty over own financial institutions. The trade between the GCC countries is less than 10% of their total trade. Their economic structures are very similar and the room for productive integration is small. They all effectively peg their currencies to the dollar to achieve exchange rate stability. So if the GCC central bank includes four members instated of five, there will not be much economic losses if the UAE does not join. The only thing that will suffer is that the pooling of markets may suffer a little bit because the second largest GCC economy may go the other way. But the GCC will lose much more politically and this will be damaging to all. Therefore, the GCC should happily accommodate the return of UAE to its fold.
How Can GCC Accommodate UAE?
How can the GCC accommodate UAE? First, the GCC central bank should have its first chairman of the board of governors from the UAE for its first term. If Bahrain, Kuwait and Qatar (and maybe Oman) are not interested in having a board chairman from their own nationals in future terms, then the UAE governor should be the board chairman for the second term. Second, the place of the central bank should be rotated among the GCC countries. The time period for the rotation is a matter of details. If the three or four GCC countries mentioned above are not interested in hosting the GCC central bank, then the rotation should be between Saudi Arabia and the UAE. Third, some of the GCC’s 20 institutions should be hosted in the UAE. It seems that UAE wants to take more active role at the GCC and Arab World levels. It seems that the UAE’s increasing economic power is fueling its political ambitions. It is now showing ambition to host the Arab League. I support that.
What should the UAE do if negotiations reached a deadlock and the status quo prevails? The UAE should still be a member of the future GCC Union and at the same time should keep its own currency and its central bank akin to what Great Britain has done with the European Union. It should keep its membership in the GCC Customs Union and follow the same GCC Common Commercial Policy (GCCCCP). If the GCC Union is materialized and adopts free movements of labor and capital as well as trade, the UAE should sign to that as well. In such a special situation, the UAE being outside the GCC Monetary Union would badly need an anchor for its currency. It should examine Kuwait’s experience with a basket of currencies. What is good for Kuwait’s exchange rate should be good for UAE, which has an even more diversified and larger economy. The US dollar will weaken further in the future as the United States would add about $7trillion to its federal debt in the next five years as a result of accumulating deficit in the federal budget and relatively low economic growth. The US government would find it imperative to issue more Treasury securities to finance the future federal deficits and the Federal Reserve will see necessary to monetize the deficits. This case, if it happens, is a recipe for a weakening dollar for several years to come. The UAE and the other GCC countries should be aware of that.
Copyright MEES 2009.
