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GCC Single Currency: Monetary Independence First

A single currency for the Gulf Cooperation Council emerged as one of the highlights of the discussions held between the finance ministers of the member states in Riyadh on the weekend. Some ministers pointed out that the current global financial crisis has in fact strengthened the case of a single currency to be managed by a single central bank through a unified monetary policy.

The GCC states have set the Year 2010 as the deadline for the monetary union. But there is little clarity on the progress member states have made on the reforms, including revaluation of their currencies, needed to reach the stage of monetary union by then. In fact most states, it seems right now, are happy to piggy back the rise of the US dollar to which their currencies are pegged. The rising dollar means currencies pegged to it are also on the rise. A stronger currency results in lower cost of imports and helps dampen imported inflation. Gulf countries in general are big importers of food and non-oil commodities and have seen domestic inflation surge as global prices rose.

However, the dollar peg comes at the cost of monetary policy independence. Any country with its currency pegged to the dollar has to keep its benchmark interest rates exactly where the US Fed has set it for the US economy.

Given that the Gulf is an emerging market, economies in the region are likely to grow at a higher rate than that of a mature economy like the US. Even during an economic downturn, such as the one now facing the world, emerging economies are less likely to go into a secular recession. That means their monetary policy will remain out of step with that of the US which will need to sustain interest rates at a lower level for a much longer period.

That means that despite the short-term benefits, an economy with a dollar peg would in fact be exposed to the danger of a resurgence of inflationary growth. Unless Gulf policymakers foresee a sustained deflationary environment across the world, they need to move forward and claim policy independence as soon as possible. Flexible exchange rates and an independent monetary policy will then give each GCC state a better idea about the pros and cons of a single currency.