Deutsche Bank said in a report yesterday that conflicting statements from GCC officials during recent months has led them to believe a delay to the 2010 date will be announced shortly.
The GCC are officially set to adopt a common currency in 2010 with Oman joining later. This will require structural, monetary and fiscal convergence for the union to be successful. Structural and monetary convergence is already well advanced reflecting high energy dependencies and 20-year de-facto pegs against the USD.
But fiscal convergence is much lower reflecting differing oil dependencies across countries. Fiscal convergence is likely to become increasingly difficult going forward as these economies are set to structurally diverge. There is currently no mechanism to ensure fiscal policy is consistent with a common monetary policy going forward.
Several institutional requirements to adopting a common currency exist, most importantly the so-called convergence criteria. The GCC in general perform well although Qatar and the UAE do not meet inflation and none of the countries meet the foreign reserves criterion (which is narrowly defined as official FX reserve assets only).
GCC Convergence Criteria include inflation no higher than 2pp above that of the weighted GCC average; short-term interest rates no higher than 2pp above the GCC average; budget deficit of less than 3 per cent of GDP or less than 5 per cent when oil prices are “weak”; national debt of less than 60 per cent of GDP and reserves no less than four months of import cover.
Oman’s decision to delay was more a reflection of political uncertainties and in fact seems realistic on the convergence criteria. Kuwait and the UAE have been the most vocals in terms of questioning the suitability of the USD pegs. The Kuwait Dinar the most likely candidate for revaluation in our view with the authorities concerned over the loss in purchasing power from a weaker USD. Kuwait could be the first to revalue.
Structurally large CA surpluses (even at times when oil prices were low) also suggest currencies may have been overly competitive. Foreign reserve appreciation will not change the USD price of oil suggesting current account surpluses will be fairly unresponsive to any revaluation.
The Bahraini Dinar and UAE dirham see a revaluation between 10 to 15 per cent, Oman and Saudi Arabia between 25 to 30 per cent while Kuwait and Qatar are estimated to be around fair value but that does not rule out revaluation.
GCC performs poorly when estimating the potential benefits of a common currency. Intra-regional exports are just 5 per cent of total and political integration is unlikely.
The continued peg to the US dollar by the GCC mean interest rates are tied to the fed rising inflation leaves real rates negative Macro outlook nevertheless remains bright.
