BUOYANT global oil and gas prices have bolstered GDP economic growth across the Gulf region as the world emerges from the Covid-19 Pandemic lockdown. Collectively, the GCC countries (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates) account for 40% of proven oil reserves.(1) The ongoing conflict in  Ukraine has provided an additional boost to hydrocarbon prices, which has solidified the GCC’s position as one of the most vibrant and dynamic regions globally. This is in marked contrast to the European Union, which  continues to grapple with recession.

Simultaneously, the GCC countries are channeling the revenues earned from energy exports into their sovereign wealth funds (SWFs), thus enabling them to invest in a wide range of  economic sectors. Notably, these investments encompass renewable energy, climate change technologies, EV manufacturing, healthcare and tourism.

 

Tourism in the Gulf region is likely to be further enhanced by a promised move to introduce a Schengen-style visa for tourists. Bahrain’s Minister of Tourism, Fatima al-Sairafi says: ‘We see this could happen very soon because we see people flying from abroad to Europe usually spending their time in several countries rather than in one country.’ Speaking at a panel during the Arabian Travel Market held in Dubai in May (2023), she further underscored, “We really saw the value this can bring not to each country but all of us”.(2)

 

The Foundations of Trade Activity

 

GCC members are focusing on the issue of boosting trade within and beyond the bloc. This strategy is supported by the absence of exchange controls within the GCC. Moreover, a concerted effort has been made to harmonise tariff rates and tackle non-tariff barriers, such as differing environmental regulatory regimes and standards. These efforts are further augmented by the development of modern transport infrastructure, principally airports, ports, highways and railway links. As Suhail bin Mohammed Al Mazrouei, the UAE’s Minister of Energy and Infrastructure, observed when launching the National Programme for Infrastructure Development this August (2023),“The UAE is a pioneer in adopting ambitious initiatives and projects and issuing regulations that ensure our dams, roads, and buildings are state of the art”.(3)

 

This move towards greater harmonisation makes the Middle East a far more attractive place to invest; it also reinforces the perception of the GCC as a vibrant trading bloc, similar to the EU, NAFTA and the CPTPP Pacific Rim trading bloc. The CPTPP includes 12 members, notably the USA, Canada, Australia, Japan, Singapore and Peru. The UK signed up to CPTPP on 16th July this year, although its membership has yet to be formally ratified.

Meanwhile, as part of its post-Brexit strategy, the UK is making excellent progress with trade negotiations aimed at signing a Free Trade Agreement (FTA) with the GCC before the end of this year. As a trading block, the GCC is party to several FTAs - including with Singapore and the EFTA countries (Switzerland, Liechtenstein, Norway, Iceland). Currently, it is engaged in  FTA negotiations with its leading trade partners, China, South Korea and UK.

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The GCC levies no custom duties between its six members, while the GCC’s common external tariff is applied at a minimum rate of 5%. All six GCC countries levy additional excise taxes on cigarettes, (e.g. the Kingdom of Saudi Arabia [KSA] applies a rate of 100%), carbonated drinks (KSA applies a rate of 50%), and energy drinks (KSA levies a rate of 100%).

 

 

Currency Union Prospects

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Creating a common currency area for GCC members has been a long-standing goal. Indeed, when the GCC was founded in 1981, the aim of establishing such a common currency was explicitly recognised in Article 22 of the Council’s Unified Economic Agreement, which states: “The member states shall seek to coordinate their financial, monetary and banking policies and enhance cooperation between monetary agencies and central banks, including an endeavour to establish a common currency in order to further their desired economic integration”.(4)

 

Initially, in the 1990’s progress was made towards the goal of monetary union. The GCC members promoted new steps to integrate their economic and financial systems. Free movement of national goods, labour and capital across national borders was solidified, alongside the harmonisation of customs administration and procedures. These reforms were complimented with a range of measures aimed at promoting foreign direct investment and intraregional capital flows, along with the review of investment codes and stock exchange regulations. ATM machines were interlinked and GCC members were allowed to open bank branches in other GCC jurisdictions.

 

However, the original timetable to adopt a common currency by 2010 has not been met. Nasser al-Kaud, Deputy Assistant General for Economic Affairs at the GCC, conceded in a speech given on 24 March 2009, that the original deadline for the establishment of the monetary union would not be met due to the financial crisis and a lack of cooperation between the GCC member states.

 

The financial tsunami that gripped the world in 2008 certainly partly explains this lapse, as much as the challenge centred around the issue of national sovereignty, particularly concerning governments’ ability to devise their own fiscal arrangements. As with the history of euro, where members such as Greece struggled to maintain their economic competitiveness when barred from devaluing their currency, questions were raised about the ability of all six GCC members to comply with the convergence criteria for managing a common currency area.

 

Common currency areas require a harmonised tax regime to fulfil the potential benefits their advocates promote. In practice, the euro has faced recurrent challenges because of the reluctance of EU member states to harmonise their fiscal regimes. Hence, for instance, Ireland enforces a corporation tax rate at 12.5% while France charges a rate varying between 25% and 27.5%.(5) Given such disparities, it is unsurprising that many global corporations opt to open headquarters in Dublin because their tax bill is significantly reduced.(6) While the OECD and EU Commission persist in their efforts to standardise fiscal regimes and discourage perceived tax havens, certain national governments such as Ireland and Lithuania continue to resist such initiatives.(7)

 

Renewed Calls for a Common Currency Area

 

For over two decades GCC members have adopted a de facto peg of their currencies to the U.S. dollar ($). This arrangement was formalised officially from January 2003. The only exception is Kuwait, which moved to an undisclosed basket of currencies in an attempt to curb what was seen as the damaging impact of the peg on imported inflation. Pegging Gulf currencies to the US dollar offers several notable advantages, principally because a large proportion of the financial assets held overseas by GCC central banks, sovereign wealth funds, and the private sector are denominated in U.S. dollars.

 

Accordingly, a peg to the dollar provides a degree of certainty with respect to the valuation of these assets. If currencies were allowed to fluctuate freely, there would be an exchange rate risk. The fact that this is mitigated by pegging currencies is illustrated by the forward market for GCC currencies, which demonstrates that the rate fixed for a transaction in a year or more’s time is very similar to the spot rate (see Table 1).(8)

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Forward Rates of GCC Currencies

 

 

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Source: fxempire.com, September 2022.

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Recently, however, there have been renewed calls to establish a common currency areas across the Gulf. Khalaf Ahmad Al-Habtoor, a leading businessman in the UAE who has long argued for GCC monetary union, claims that, “Such a step would reduce dependency and ensure more independence in shaping monetary policies, in addition to enhancing economic stability and consolidating regional integration”.(9) He believes adopting a common currency would, “consolidate the position of the UAE and Saudi Arabia as global leaders, thanks to their infrastructure, which has solid economic, social and political foundations”.(10) But practical challenges, like harmonisation of tax policy, must first be addressed before monetary union can be realistically considered.
 

The crucial question to be posed is whether GCC members are prepared to surrender an important element of national sovereignty to seize the benefits flowing from lower transaction costs and the elimination of exchange trade variability?

 

Monetary union would require a mutual surveillance mechanism in order to enforce fiscal discipline among GCC members. However, this is bound to trigger complaints — from traders and consumers alike — that the original exchange rate at which GCC members joined was somehow inappropriate. This is an argument regularly heard in Italy, where a significant proportion of voters judge the exchange rate first applied for the euro against the lire was too high. In truth, the Italian economy found it challenging to match German productivity levels, exacerbated by the inability to devalue the currency to maintain competitiveness.

 

Given the buoyant trade balances now enjoyed by GCC members, and the recent rapprochement in relations between Qatar and Bahrain, Saudi Arabia and UAE, the prospects for pursuing the idea of a common currency within the GCC trading bloc looks more encouraging. But the practical challenges that need to be addressed for such a monetary union remain daunting. The points made by Andreas Schaechter in a paper on ‘Potential Benefits and Costs of a Common Currency for GCC Counties’, published by the International Monetary Fund (IMF) 20 years ago, are just as true today. Schaechter noted that any future monetary union would “need to be supported by appropriate macroeconomic policies, a range of structural reforms, and strong political commitment to be fully effective and beneficial for its members”.(11)

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Greater Cooperation with China: The World’s Second Largest Economy

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A more likely trajectory for GCC economies involves the collaboration with China. Following a meeting between President Xi Jinping’s and GCC leaders last December, commentators began referring to this development as “the birth of the petroyuan”.(12) As Zoltan Pozsara former Credit Suisse analyst emphasized, China is set to become a significant consumer of hydrocarbons supplied by GCC members. What is more, we are also likely to witness “all-dimensional energy co-operation” involving joint exploration and production in places such as the South China Sea, along with major investments in refineries, chemicals and plastics co-funded by GCC SWFs. Naturally, China’s leadership would prefer to see these investments paid for in renminbi (¥). To incentivise GCC investors, Chinese authorities have offered to make the renminbi convertible to gold on the Shanghai and Hong Kong gold exchanges, thereby providing a greater degree of certainty.(13)

 

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A Candid Assessment

 

The prospect of the GCC adopting a common currency and forging a monetary union remains a long-term objective. Nevertheless, the GCC is making significant progress with respect to harmonising a host of non-tariff barriers to trade as well as streamlining regulations. The dollar remains the dominant currency for trading oil and gas as well as for overseas asset investment, yet China is likely to pose a growing challenge to this traditional dominance as it agrees more joint venture partnerships with GCC members and buys an increasingly large proportion of their oil and gas. This trend, in turn, broaches a real challenge to EU countries looking to diversify their sources of energy supply. To ensure the security of energy supply across Europe over the next decade, EU member states must elevate their efforts in political, diplomatic and commercial areas. Are European leaders prepared to rise to this challenge?

 

        

(19/09/2023)

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Notes

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(1) Why We Shouldn’t Underestimate China’s Petro-Yuan Ambitions by Alex Kimani - Jan 05, 2023, Oil Price.com, https://oilprice.com/Energy/Energy-General/Why-We-Shouldnt-Underestimate-Chinas-Petro-Yuan-Ambitions.html

(2) New Schengen-style visa planned for GCC countries: Minister Tamara Abueish, Al Arabiya English, 4 May 2023. https://english.alarabiya.net/News/gulf/2023/05/04/New-Schengen-style-visa-planned-for-GCC-countries-Minister

(3) UAE announces national programme for infrastructure development by Divsha Bhat, Gulf Business, 1 August 2023, https://gulfbusiness.com/uae-new-programme-for-infrastructure-development/

(4) https://investmentpolicy.unctad.org/international-investment-agreements/treaty-files/3105/download

(5) PWC worldwide tax summaries, 1 August 2023, https://taxsummaries.pwc.com/france/corporate/taxes-on-corporate-income

(6) Ireland has agreed to raise its corporation tax rate to 15 percent in 2023 following sustained pressure orchestrated by the OECD. This 15 per cent rate will be levied on more than 1,500 subsidiaries of mostly American multinationals as well as 56 Irish-owned multinationals. Taken together, these companies employ nearly a quarter of the workforce and generate half of Ireland’s income taxes. For further details see ‘Ireland to join global pact on corporate tax after winning concessions’ by Shawn Pogatchnik, 7 October 2021, Politico. https://www.politico.eu/article/ireland-to-join-oecd-pact-on-corporate-tax-after-winning-concessions/

(7) see ‘Ireland to join global pact on corporate tax after winning concessions,’  by Shawn Pogatchnik, 7 October 2021, Politico. https://www.politico.eu/article/ireland-to-join-oecd-pact-on-corporate-tax-after-winning-concessions//

(8) ‘Rethinking the Currency Peg in the Gulf Arab States, by Professor Mohamed Z Bechri, The Arab Gulf States Institute in Washington DC,  7 December 2022, seehttps://agsiw.org/rethinking-the-currency-peg-in-the-gulf-arab-states/#:~:text=The%20Gulf%20Arab%20states%20adopted,became%20official%20starting%20January%202003.

(9) ‘GCC currency would give state the power to chart their own course’ by Khalaf Ahmad Al-Habtoor, Arab News, 25 May 2023.

(10) Ibid.

(11) ‘Potential Benefits and Costs of a Common Currency for GCC Countries’, International Monetary Fund (IMF), by Andrea Schaechter ,  29 August 2003.    https://www.elibrary.imf.org/display/book/9781589062191/ch04lev01sec01.xml

(12) See Financial Times, ‘A new world energy order is taking shape’  by Rana Foroohar,  3 January 2023.

(13) Ibid.

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