SHARJAH, 31 December 2004 — The “Gulf dinar” — the common currency that the Gulf Cooperation Council (GCC) member states plan to have in the year 2010, will have far-reaching implications, including a big boost to inter-GCC trade, and could help the region’s countries diversify their economic base away from hydrocarbons, says a research paper.

The study, prepared by the Dubai-based Gulf Research Center (GRC), notes that the relevance of the Gulf dinar is not only because it will be the single currency of an economic bloc that has a GDP of $388 billion and controls 45 percent of the world’s known oil reserves, but also because currency unions invariably increase the levels of intraregional trade.

It will be, after the euro, the world’s most significant currency union, noted the paper, titled “Establishing a successful GCC currency union — preparations and future policy choices” and authored by GRC researcher Emilie Rutledge.

Furthermore, the Gulf dinar could become the currency to which other Arab and Muslim countries could peg their currencies as an alternative to the American dollar.

The paper argues that if the GCC governments legislate and enact the necessary preparatory policies and create the appropriate institutions, the formation of a GCC currency union and the launch of a Gulf dinar will bring a series of economic and political benefits to the region.

“A currency union is more than simply rhetoric, it is a binding economic commitment that, if inadequately planned and prepared for, could have negative consequences,” it says. “The willingness of all the regional governments to become more accountable, provide regular transparent economic data, publish annual budgetary reports and forecasts, submit to greater fiscal constraints and scrutiny and devolve some powers to supranational GCC institutions such as a central bank will be critical.”

The paper says: The currency union is sure to increase levels of intraregional trade and investment over time. The elimination of transaction costs brought by the single currency will facilitate GCC cross border business and, at the same time, allow direct comparison of costs and prices that will enhance competition and improve overall economic efficiency.

Levels of foreign direct and portfolio investment are also expected to increase as will the retention level of regional private wealth.

A strong independent Gulf dinar that the GCC uses to invoice its oil sales will not only provide the region with substantial seigniorage revenues but would also become the strongest currency in the Muslim world and one which Arab and Muslim states may choose to hold and peg against as an alternative to the US dollar.

Once established, the GCC leadership may decide to invoice their hydrocarbon sales in the Gulf dinar, moving away from the current dollar pricing system.

There are some clear incentives for doing so. The Gulf dinar would have great potential to become a reserve and anchorage currency, providing the GCC with significant seigniorage revenues. Furthermore, it could become the reserve currency of choice for Islamic and Arab central banks for a combination of religious and political reasons.

The GCC currencies are all currently pegged to the US dollar but post-2010 it would be wise to consider the benefits of an alternative arrangement such as a peg to the euro or to a trade weighted basket of currencies, the report said.

Trade with euro zone countries and Asia has grown significantly over the past 10 years and is likely to continue to do so. Therefore an exchange rate which maintains stability of trade revenues against these economic blocs would be economically prudent.

The recent decline in the US dollar has weakened the GCC currencies and has increased the relative price of imports particularly from the euro zone. Real wealth has been lost from the holding of reserves in dollar assets.

Moreover, pegging to the dollar alone has meant that GCC interest rates are de facto broadly determined by the US Federal Reserve. As a result, the GCC states’ monetary policy is based on US economic conditions rather than those of the GCC. Generally when oil prices are high, the US Federal Reserve is prompted to lower interest rates in order to avoid an economic downturn caused by higher input costs. While at the same time the effect of higher oil prices in the GCC economies creates massive increases in liquidity, this combined with relatively low interest rates can create asset price bubbles. Indeed, US monetary policy is likely to exacerbate the pro-cyclical tendencies that are prevalent in the GCC economies.