The Gulf Cooperation Council currency union planned for 2010 would be unlikely to affect the government bond ratings of its six member states.
Many of the common advantages of a currency union would be muted in the case of the GCC while the disadvantages would also be less relevant given GCC states' exchange rate pegs, heavy hydrocarbon dependence and a lack of accompanying institutional reform.
Most economic studies indicate that currency unions tend to encourage and facilitate trade between member states, chiefly through the removal of exchange rate volatility and transaction costs within the currency area.
The potential boost to trade is one of the benefits most often touted by advocates of euro zone membership, for instance, and there is considerable evidence that trade within the euro zone has indeed benefited from the single currency.
However, in the case of the GCC, the stimulus to trade from the adoption of a common currency would likely be more limited than has been the case with other currency unions, for two main reasons.
First, there is already very little exchange rate risk within the GCC because all six member states have longstanding pegged exchange rates - Kuwait's to a dollar-heavy currency basket and the others straight to the dollar.
Hence, traders within the GCC already enjoy a stable exchange rate environment. Secondly, there is less potential for trade within the GCC than in other currency unions because of a lack of economic diversification, with all six GCC economies wedded to hydrocarbons.
In addition, the impressive institutional reforms which boosted the success of the euro zone, for example, are not yet present in the case of the planned GCC currency union.
In the case of the euro zone, the mandatory adoption of the acquis communautaire (commonly agreed EU rules and practices), the establishment of the highly regarded European Central Bank and Eurostat and their enforcement of the stringent Maastricht economic performance criteria have led to significant improvements in the institutional frameworks and policy predictability of member states.
Similarly, the primary disadvantages associated with membership of a currency union - i.e. ceding control over independent monetary and exchange rate policies - are less immediately relevant for GCC members given that GCC authorities have little room for manoeuvre in setting monetary policy as a result of their currency pegs. Paradoxically, the formation of a currency union presents an opportunity for the GCC to have a more flexible exchange rate regime.
For the smaller GCC members, the argument that they will benefit from protection against potential currency crises, which has boosted the ratings of some smaller euro zone members, is less compelling given these countries' generally strong balance of payments, sizeable external assets and long history of exchange rate stability.
Although the economic cycles of the GCC states are broadly in tune, the risk of asymmetric shocks is likely to grow over the longer term as some states' hydrocarbon reserves deplete more quickly than others. Those GCC states with fewer hydrocarbon resources may therefore benefit from exchange rate flexibility over the longer term as an aid to external competitiveness.
The writer is vice-president/senior analyst at Sovereign Risk Unit, Moody's Middle East Ltd.
