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(Menafn-KhaleejTimes) DUBAI — The lack of fiscal convergence is one of the trickiest aspects of achieving monetary union in the GCC by 2010, according to Deutsche Bank.
In the context of the recent statements by GCC officials on the bumpy nature of GCC's progress towards the 2010 target of achieving monetary union, Deutsche Bank has pointed out in a report that the on the surface the GCC seems an ideal candidate for monetary union with a large degree of structural and monetary convergence already underway and little costs from surrendering monetary policy. But as these countries will become structurally more diverse over time, and there is, as yet, no appropriate anchor to ensure sustainable fiscal convergence. This could pose problems to the Monetary Union.
According to the report, while fiscal balances tend to move broadly in the same direction across the GCC, given the fairly strong correlation with the oil price, the actual level of fiscal balances are very different (reflecting differences in the oil dependencies). This is highlighted in the divergence in fiscal positions in 2006 which range from a projected surplus of 4.2 per cent of GDP in Bahrain to a surplus of 58 per cent of GDP in Kuwait.
The very high correlation between government revenues and the oil price meant, in the past, that government spending also soared during periods of high oil prices but did not drop back equally quickly in response to weaker oil prices (1980-1990s). Spending growth has, however, been restrained during recent years averaging just 17.5 per cent per annum for the GCC during 2003- 6 compared with revenue growth of almost 32 per cent.
In the economic aspects of convergence, the GCC also face several institutional requirements to adopting a common currency. The GCC countries have (preliminarily) agreed on five convergence criteria by which each country will be assessed prior to the adoption of a common currency. The criteria are largely based on Euroland's Maastricht criteria with four out of the five criteria almost identical covering the budget deficit, government debt, inflation and interest rates. The additional GCC criterion covers forex reserves in months of imports. The budget deficit and debt criteria are easily met with budget surpluses in all six countries and low debt levels. Even in Saudi Arabia which previously had a debt burden in excess of 100 per cent of GDP (1999) this has come down sharply to an estimated 29 per cent of GDP by end 2006.
On the interest rate and inflation criteria the currency pegs broadly ensure that inflation and short-term interest rates move in line. Bahrain, Kuwait, Oman and Saudi Arabia meet both the criteria based on 2005 and projected 2006 data while Qatar and the UAE have not met the inflation criteria since 2003. They do nevertheless continue to meet the interest rate criteria.
The report points that there is, a major drawback in terms of the absence of any mechanism to ensure sustainable convergence. Moreover, it is not clear that the Masstricht criteria for debt and the fiscal balance are even appropriate for the GCC. According to the Deutsche Bank, estimating some measure of the expected benefits from a common currency in the GCC is also tricky. Prior to the introduction of the euro in 1999 one of the main benefits was generally regarded as the reduced transaction costs from intra-regional trade. Euroland intra-regional exports were around 52 per cent of total exports prior to the adoption of the euro. A striking feature of the GCC is the very low degree of intra-regional trade, a reflection of the fact that all countries are very sizeable energy exporters. Intra-regional exports were just 5 per cent of total exports in 2005 but intra-regional non-oil exports are, however, much larger at around 30 per cent of total exports (though still less than 2 per cent of GDP). As all six economies diversify away from oil going forward intraregional exports will undoubtedly increase suggesting that this benefit, although currently low, will increase in importance. However, the benefit of reduced transaction costs from a common currency in the GCC currently seems low.
The costs of currency union seem low. All six countries effectively surrendered monetary policy some time ago suggesting the move to a common currency would have little impact on monetary policy.
Despite the scepticism from different quarters,the move towards a common currency being a political decision, the report suggests that there will be some form of Monetary Union in 2010 although there are undoubtedly risks that this will be delayed.
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