The United Arab Emirates (UAE) withdrawn from the planned Gulf monetary union came as a big surprise as it exposed how petty political goal can undermine bigger economic gain. Surely, for the UAE, the ability to house the Gulf central bank in its capital, Abu Dhabi, seems more important than the proper materialization of the Gulf monetary union, a project in the making for almost 30 years.
How reasonable is UAE’s decision to withdraw from the GCC monetary union? What criteria should we use to determine who is a justifiable candidate to host the Gulf central bank? The aim of this column is to shed some light on these critical questions.
On the political front, UAE is perhaps a deserving candidate as it applied to host the Gulf central bank in 2004, much before than Saudi Arabia who applied in 2008. Besides, the plans to diversify government institutions across Gulf countries favor UAE since the GCC Secretariat is already located in Saudi Arabia, while other GCC institutions are located in other GCC countries. The fact that the remaining GCC members (Bahrain, Kuwait, and Qatar) did not show interests in hosting the Gulf central bank, give a political boast to UAE’s proposal of hosting the Gulf central bank in Abu Dhabi.
Besides, there is no clear rule that a common central bank should be located in the most populous or largest economy in the group (i.e. Saudi Arabia). For example, Nigeria is considering joining a monetary union with five other West African countries (The Gambia, Ghana, Guinea, Sierra Leone, and Liberia). Nigeria, by far the most populous country in the group (147 million out of 192 million in the six countries combined) and the largest economy in the group (USD 214 billion of GDP out of USD 238 billion GDP in the six countries combined). Yet, the new West African Central Bank will be located in Accra, the capital of Ghana (with only 22 million people and a GDP of USD 16 billion). By this token, either Bahrain or Qatar seems a plausible candidate to host the Gulf central bank.
On the economic front, the notion that UAE has the right ingredients (e.g. largest financial sector by assets, highly open economy) should be interpreted with caution. Germany was chosen to host the European Central Bank not solely on the basis that it is the largest economy in the Euro area, rather the Bundesbank, Germany’s central bank, had a proven track record of controlling inflation through the second half of the 20th century, and is the most influential member of the European System of Central Banks. This made the German mark one of the most respected currencies, to which many European currencies were pegged before embracing the Euro.
Certainly, none of the central banks in the Gulf region exhibit leadership to succeed as the contender of Gulf central bank. Aside from the day-to-day challenges in implementing meaningful monetary policy, a central bank is also responsible for undertaking serious research work, especially on economic issues. One hardly finds any evidence of systematic scholarly research while browsing GCC central banks’ websites.
Another issue of interest is the availability of economic data that central banks use to evaluate the future path of the economy. The availability of high quality data opens up rich possibilities of doing high quality quantitative research, which has a positive effect in improving the overall research environment. GCC countries differ among themselves in terms of economic data coverage. UAE is infamous for its poor data quality of consumer prices and national income aggregates, while public availability of Qatar’s balance of payment data is virtually nonexistent. In this regard, both the Kuwait and Saudi Arabia stand out as the best barometers of the quality of data published within the GCC region, although more work is needed to further improve the data coverage.
Clearly, the criteria to host a common central bank should be dealt more objectively. Lacking monetary policy independence due to the exchange rate peg, the GCC central banks could be evaluated on the basis of maintaining discipline in the domestic financial sector, adequacy of data dissemination, and especially research output—when deciding on the location of the Gulf central bank. Bahrain is probably as financially advanced as the UAE is, Kuwait has a developed futures market, while Qatar is rapidly promoting its financial center; thus UAE has to offer something extra in support of hosting the Gulf central bank. Certainly investing in economic research is one area that would make UAE stand out amongst the others.
The UAE’s pull out announcement is likely to weaken the proposed currency union. Nevertheless, the present crisis also offers a new chance to collectively work on fulfilling several preconditions for the union including coordination of payment systems, improvement in data gathering and sharing, harmonization of legal codes, among many others. As such, UAE’s decision doesn’t affect its broader membership in the GCC, such as the Gulf Common Market which was launched in January 2008. While goods and capital can move quite freely cross GCC countries, a lot of work is needed to eliminate the entrenched rigidities in GCC labor markets. The finance and economy leaders should work removing obstacles facing the path to monetary union.
While UAE’s decision to withdraw was largely motivated by political considerations, should UAE decides to opt out from the union, the authorities can make a firm decision by conducting a counterfactual analysis, judging what would happen under alternative states of the economy. A natural question to ask in this context is whether output in the UAE would be higher and prices lower if the UAE joins the monetary union. Such type of conditional analysis would help to assess the costs and benefits of not joining the union in economic terms.
If properly implemented, a GCC monetary union can prove to be very useful for the six member countries. Even though monetary policy independence would be lost as a result of the union, however, this is not a big deal for the Gulf countries as they are used to the imported monetary policies from the United States. Most importantly, under a monetary union the sovereignty of the fiscal policy is not affected. Given that fiscal policy works as the key driver of economic growth in the GCC region, forming a monetary union is expected to yield more benefits than costs. Once again, the success of a monetary union depends on fulfilling many preconditions; fortunately the Euro serves as an excellent model in dealing with various challenges that the GCC countries face.
— The author is a research economist at Qatar Central Bank. Views are author’s own.