IMF suggests managed currency float

Dubai: The International Monetary Fund (IMF) said yesterday that a managed currency float in the Gulf could allow greater monetary independence to control inflation and facilitate real exchange rate adjustment to real shocks while, at the same time, suggesting a more flexible exchange rate regime "as a longer-term possibility".

It's latest report also said that achieving a monetary union by 2010 "would be a challenge". The IMF stressed the importance of creating the proper institutional infrastructure for launching a currency union.

"A basket peg of major currencies could provide an intermediate exchange rate regime that introduces some flexibility in the exchange rate and reduces the adverse effects of swings in the value of major currencies," the IMF said in its latest report.

"However, a basket peg might be less easily understood and provide a less secure nominal anchor than a single currency peg."

The experience of Kuwait with its basket peg, which was adopted in May 2007, was considered highly germane but too short-lived yet to yield definitive conclusions, it said.

"Peg to the US dollar has been a blessing in disguise for the Gulf countries, although the current strength of the US dollar is not supported by market fundamentals," economic analyst Raju Menon, managing partner of Morison Menon chartered accountants, told Gulf News.

"The current strength of the US dollar comes from the psychological impact and it is temporary."

The six states of the Gulf Co-operation Council (GCC) are committed to creating a monetary union by 2010, although major hurdles, such as the choice of the venue of the GCC Central Bank as well as the name of the currency remain undecided - apart from streamlining of fiscal policies.

Following the formation of a customs union in 2003, a common market was launched earlier this year, although Kuwait and Oman have opted out from the monetary union. Efforts are on to delay the union to accommodate both.

Menon said, "Although it appears that the Gulf countries are close to a monetary union, it will be difficult for them to achieve the goal."

Experience

Citing the experience of the European Union and the single European currency, Menon said they should go ahead with the monetary union anyway. "The EU launched the euro without Britain - a major partner of the EU. If need be, the Gulf states should go ahead with the monetary union without Oman and Kuwait - they could join later."

One of the critical decisions in the formation of a monetary union is the choice of an appropriate exchange rate regime for the single currency. GCC members agreed in 2003 to peg their currencies to the US dollar and to maintain the parity until the establishment of the monetary union in 2010.

"The choice of the exchange rate regime for the GCC monetary union would need to be determined in light of economic conditions and prospects prevailing at the time the currency union is established," the report stated.

The economic criteria for determining the appropriate exchange rate regime should include: external and internal stability, international competitiveness, policy credibility, transactions costs, and the nature of shocks.