With customs union, Gulf edges toward closer economic ties

DUBAI Mon Jul 23, 2012 7:06am EDT

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DUBAI (Reuters) - In April this year, a queue of thousands of trucks built up at the Al Ghuwaifat border crossing between the United Arab Emirates and Saudi Arabia. Weary drivers ate and slept in their cabs, some for as long as several days, because of a slow customs clearance process.

It took several weeks to reduce the logjam to normal levels. The incident underlined the difficulties faced by the six rich oil exporting countries of the Gulf Cooperation Council (GCC) as they edge toward closer economic integration.

Saudi Arabia, the biggest Arab economy, is leading moves toward political and economic cooperation, which it believes would give the mostly Sunni-led monarchies of the Gulf more power to withstand any confrontation with Shi'ite Iran.

Closer business ties within the GCC, which consists of Saudi Arabia, the UAE, Kuwait, Qatar, Oman and Bahrain and has a combined annual output of about $1.4 trillion, could have big repercussions for companies and consumers.

Projects already underway or under study include a customs union, a joint value-added tax and even the introduction of a single currency.

But there are large obstacles to closer integration, including bureaucratic and administrative inefficiencies, as in the case of the border crossing, as well as old rivalries and a desire among smaller Gulf states to retain their autonomy.

Even the countries' wealth sometimes becomes an obstacle; with economies already growing robustly, there is less incentive to make radical changes to achieve faster growth.

"We will not see any picking up the speed on going into the monetary union any time soon," said Abdulkhaleq Abdullah, a political scientist in the UAE.

"Having said this, it does not mean that the GCC is not going to pick up other aspects of integration and speed up coordination and cooperation at other levels. I see the customs union speeding up in the future."

CUSTOMS UNION

The GCC launched a customs union - a free trade area with a common external tariff - in 2003; this has largely been successful in removing overt trade barriers within the bloc.

But the full functioning of the project has been delayed by disagreements over a formula on how to divide customs revenues between the governments. In June, the GCC set up a customs union authority to complete the revenue-sharing debate.

"They have the deadline of 2014 to finish everything. Distribution of customs revenues is the main thing," said a Gulf official familiar with the process. "It's more about how to solve it, the distribution and rates."

Options include dividing revenue from customs according to the level of imports, population or the share of gross domestic product of individual countries, a GCC official said in October.

Labour movement is free for GCC citizens, but this is less important than it might seem since so many workers in the Gulf are expatriates, brought in to man oil rigs and retail and service businesses. Migrant workers from other countries made up around 40 percent of the total GCC population of 47 million, according to a United Nations estimate for mid-2010.

No more than 21,000 GCC nationals are employed in a GCC state other than their country of origin, a 2011 study on Gulf labour mobility showed.

"The region is adopting a model which supports full mobility amongst its citizenry," Zahra Babar, a project manager at Georgetown University School of Foreign Service in Qatar, wrote in the research paper. "However, there are no parallel steps being taken to construct a supranational mechanism for addressing other forms of movement to the region."

Other GCC projects have also run into headwinds. For six years, Gulf countries have been considering whether to introduce a value-added tax, perhaps at a unified rate of 5 percent, in order to cut their reliance on oil income. The countries would need to launch the tax simultaneously around the region to prevent a shift of consumer spending to untaxed areas.

Talks have bogged down in the technical stage, however, and a date to introduce the tax remains undecided. With Brent crude oil around $100 a barrel, some $20 above the price which most GCC countries need to balance their budgets, there is little immediate need for governments to raise more revenue.

"It's always when oil prices are up, nobody talks about the VAT," said a Gulf government official who declined to be named because he is not authorized to speak publicly. "I do not see any new taxes coming in the next two or three years."

Similarly, some firms hope the GCC will harmonize its financial market rules and bank licensing procedures; this could encourage more flows of capital around the region and help Gulf financial institutions grow by expanding into new markets.

So far, however, the Gulf remains a patchwork of different regulatory and licensing regimes. With the region awash in oil money, there is no pressing need to boost capital inflows.

SINGLE CURRENCY

The GCC's most ambitious economic integration project, creating a single currency, looks unlikely to move ahead for the foreseeable future.

In theory, monetary union could encourage a fresh wave of trade and investment around the region. Although intra-GCC trade soared to $65.4 billion in 2010 from $19.8 billion in 2003, official data show, that is still only a small fraction of the GCC's total trade volume of nearly $1.3 trillion last year.

But the single currency project suffered a major blow in 2009, when the UAE, the second biggest Arab economy, quit over Riyadh's insistence that Saudi Arabia would host the joint central bank. Much smaller Oman had already dropped out in 2006, saying it was not ready.

In March 2010, Saudi Arabia, Kuwait, Qatar and Bahrain set up a forerunner to the Gulf central bank, a "monetary council", but the institution has kept a low profile since then.

"They are meeting regularly and they are still on the matter of organizing institutions - there is no decision yet on any program, timings," the Gulf official said.

The absence of the UAE, seen as an economic counterbalance to Saudi Arabia, is an obstacle to further progress towards monetary union since Kuwait and Qatar may resist the influence of their much stronger neighbor over policy, analysts said.

"The monetary union minus UAE is not a monetary union, it's not feasible," said Abdullah. "They (smaller states) would rather wait and slow down until the UAE is ready to join in."

Kuwait's central bank declined to comment on progress towards monetary union. Other Gulf central banks did not reply to Reuters questions.

Meanwhile the euro zone debt crisis, where the single currency system has proven deeply flawed, has dealt another blow to supporters of Gulf monetary union. The euro zone's experience has suggested a single currency may not be viable if countries do not give up much of their fiscal independence - and Gulf states may not be willing to lose so much of their autonomy.

"Significant opposition is developing to the monetary union as a result of the euro crisis," said Mohsin Khan, senior fellow at the Rafik Hariri Center for the Middle East in Washington.

"I would say that the monetary union, despite recent meetings of foreign ministers about the political union, is being put on a backburner," said Khan, a former regional director at the International Monetary Fund.

A Reuters poll this month showed 14 of 15 analysts did not expect the Gulf to launch a single currency in the next five years. Eight out of 10 analysts said the UAE's return to the project in the future was unlikely or very unlikely.

In fact, some of the benefits of a single currency already exist within the GCC; most Gulf countries peg their currencies to the U.S. dollar, ensuring exchange rate stability, and GCC states' national currencies are sometimes accepted by shops in other GCC members. And since GCC economies focus on exporting oil and are not very diversified, there is skepticism over how much of a trade boost a single currency would really bring.

"Economic arguments for changing the current system are not compelling. The economic story, the existing arrangements function plausibly well," said Paul Gamble, chief economist at Jadwa Investment in Riyadh.

(Editing by Andrew Torchia)

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