Less than 24 hours after Dubai’s finance chief was demoted, the UAE announced its decision to withdraw from the GCC Monetary Union, putting the broader union at risk. This decision comes two weeks after a major milestone; selection of the location of the GCC Central Bank. UAE officials did not conceal their reservations about the choice of Saudi Arabia to host the institution. UAE newspapers heavily criticized the Saudis in what may have developed into a political rift.
For starters, the GCC Secretariat is already located in Saudi Arabia and other institutions in other GCC countries, and with plans to diversify the government institutions, they believed that the GCC Central Bank should be located in the UAE, given its development as one of the region’s financial hub, possibly with a presiding Saudi National.
Despite the political headlines,the GCC monetary union was already facing many hurdles and the 2010 deadline had already been abandoned, particularly as economic policies have diverged in the wake of the global and local economic crisis. Changes in the GCC policy agenda- now focusing on policy responses that would shield the GCC countries and boost growth and liquidity – took precedence over convergence and made delay more likely. Furthermore other aspects of the customs union may face delays. This decision should not come as a big surprise. Oman announced its decision not to participate several years ago. Kuwait de-pegged from the dollar in 2007 (and pegged to a dollar-dominated basket) although it vowed to join the union. The UAE’s decision to pull out, despite the fact that it was the first country to apply to host the union in 2004, versus Saudi Arabia who applied in 2008, might be a fatal blow. With only four out of six members willing to join, any potential union seems ripe for significant delays.
Even deciding upon the location of the GCC central bank was not a piece of cake, coming only after long deliberations and postponements.
The most important question is whether the monetary union will proceed or not. With the second largest GCC member pulling out, the union is left with only four members. If this adds to the hurdles the union is already witnessing, then a further delay (beyond the current open-ended timeline) is the best option that these countries would hope for instead of a formal cancellation of the union. Moreover, with the UAE pulling out any new union would be even more Saudi-dominated.
So far, markets have not responded to the UAE’s decision to withdrawal, partly because of prior sluggish progress of the union. For them, given that the union was by no means imminent, this delay is but one other form of such sluggish progress, so any market impact should be negligible. Moreover, despite the fact that the UAE has pulled out, one should not rule out a rejoining at a later date, if conditions seem to meet UAE interests more than at present.
2009 has not been a good year for currency unions. The holdup of the GCC single currency occurs at a time when the European Monetary Union is under pressure in a severe test to its cohesion. At a time of economic crisis, the EU appears to be short of the proper tools to boost economic flexibility. Within this context, GCC governments may be reluctant to give up their what sovereign flexibility they have in conducting their monetary policy. As dollar-peggers, their monetary autonomy is of course limited but, the union could limit the use of some monetary and fiscal measures over time. However, such restraints would come very far into the future, so seem unlikely to be an explanation of current moves
Meeting the convergence criteria -which include lining up budget deficits –is also doubtful as a result of the different policy responses implemented by each government, with several countries slipping into budget deficits especially in 2009. 2009 will also witness more deviation in terms of GDP figures in the GCC, doing nothing to help a smooth transition towards convergence. In 2010, the shape of recovery might differ across countries making it even more difficult to attain the convergence criteria.
However, the monetary council, the heart of the GCC Central bank should be established by the end of 2009 as if proceeding with the monetary union is still on the table. In fact there remain several significant preconditions for the union including coordination of payment systems, improvement in data gathering, sharing and monitoring among others.
An important final question; could the political differences escalate to a crisis between those two countries? That will be something to monitor in the coming months up to the GCC Summit in 2009. What is also left to monitor is the response of the other four GCC countries. Although it is highly doubtful that any of them will follow suit and pull out of the union, other political and economic dynamics may be unveiled as a result of the void that will be created by the UAE’s pullout. As noted above, the UAE’s withdrawal implies an even more Saudi-dominated union, with Bahrain already under the Saudi wing.