This article appeared originally in Gulf News: link to original article
A few years ago, and before Ireland or Greece officially exited their bailout programme, wide speculations were made about the future of the euro and what that could entail for the union.
Around the same time, comparisons were drawn between Sweden and Finland, where the latter adopted the euro and observed slower economic recovery than Sweden, which retained its own currency.
Though no longer vigorously discussed as it used to be, a currency union is always controversial, even if the dust seems to have thus far settled in regard to the euro.
At a certain point, members of the Gulf Cooperation Council (GCC) were in negotiations to introduce a single currency. Even though not much was disclosed on its launch date or the exchange rate at which it would be set, there’s no doubt that if taken forward, it wouldn’t have been an easy feat.
The matter has been shelved for now, and it most likely will not be visited anytime soon. Nonetheless, it is worth exploring the issue from a theoretical and conceptual point of view.
Peg rate problems
Considering the pros, a single currency would have enhanced economic integration for GCC member-states, especially when they share the same customs duties to their markets. Even with regard to taxes, VAT in this case, the rate was agreed across members despite not being introduced by all at the same time.
Another advantage of a single currency would have been more flexibility with currency pegs. While the Kuwaiti dinar is pegged to a basket of currencies, the rest are pegged to the dollar, which simplifies the matter of agreeing on a peg rate that works best for all countries.
This brings me though to a disadvantage when it comes to the exchange rate value. Different member-states of the GCC have different peg rates to the dollar, with the most expensive currencies being those of Kuwait, Bahrain, and Oman, respectively. Therefore, an adjustment to a lower rate could substantially boost their exports, subject to competitiveness, and deem them attractive for foreign direct investments.
It is important to note here though that recent studies do not decisively support the argument that cheaper currencies significantly support positive trade accounts.
As for GCC countries with relatively cheaper currencies, the net effect cannot be classified as good or bad in an absolute manner. Because of the peg, a devaluation to those currencies will release pressure on resources to defend the peg in times of lower oil prices, allowing higher investments into sovereign wealth funds and additional government spending in economies that were negatively affected by introduction of the single currency.
On the downside, a bigger devaluation will result in higher servicing costs of foreign-denominated debts for GCC member-states, with the loss in purchasing power harming citizens too. As a result, deciding on money supply in GCC member-states and the exchange rate will be most problematic in the way forward for the single currency.
Another disadvantage of a single GCC currency relates to the different economic structures of the countries involved. GCC member-states that are ahead in economic diversification, trade and re-exports, and have well-established financial markets, are set to gain the most from a single currency. Despite the attractiveness of a cheaper currency, it is countries with better business infrastructure, services, and opportunities that will be attracting most investments, facilitated by integration to international markets.
To conclude, the net effect of a single currency varies based on where the different economies stand in terms of their diversification and revenue sources. With the euro in mind, there will definitely be winners and losers if a single currency was introduced in the GCC. Though this doesn’t seem likely in the near future, the debate is far from concluded.
The last thought that I want to leave you with: at what exchange rate should a single GCC currency be set?