Page 61 - Aamir Rehman Gulf Capital and Islamic Finance The Rise of the New Global Players

46 PART I Background and Context

however, the likelihood of a monetary union forming in the near
future appears slim as a result of significant structural differences in
the economies of member states. Furthermore, in 2009, the UAE
announced that it was pulling out of the potential monetary union—
a critical blow to the initiative, since the UAE is the second-largest
economy in the GCC.
There are important economic and political reasons for the dollar
peg, and those reasons appear likely to persist in the near term. As
long as oil markets remain dollar-denominated, the region’s exports
and government incomes will continue to be in dollars. In addition,
the bulk of the Gulf’s foreign reserves remains in US Treasury bills, a
practice that is both a cause and an effect of the dollar peg. Currency
diversification of oil markets and reserve investments is a matter that
is often discussed, but a radical shift in either seems unlikely in the
near term.
In the realm of fiscal policy, Gulf decision makers have signifi-
cantly more latitude, but they nonetheless face constraints. As dis-
cussed earlier, public-sector income relies on volatile global energy
markets, over which the Gulf has little control. The near absence of
taxation takes away a major lever that governments typically have in
adjusting their incomes and managing through recessions. At the
same time, state benefits paid to nationals are fairly inelastic (and
growing) as a result of social expectations and the well-established
covenant between Gulf leaders and their citizens. Political participa-
tion—though growing, especially at the municipal and parliamentary
levels—is limited, but the state looks after the core economic needs of
its citizens. Changing this covenant could be highly disruptive for
ruling families in the region. 36
The component of fiscal policy in which Gulf governments
have the greatest latitude is direct investment in the local
economies through projects, state-owned companies, and other ini-
tiatives. Since Gulf reserves are so large, even small changes in the
percentage of reserves invested in local projects can have a signifi-
cant stimulus effect on domestic economies. Saudi Arabia’s 2009
expansionary budget is a prime example of the use of government
investment dollars to promote infrastructure improvement, job cre-
ation, and overall economic activity. As we shall discuss in a later
chapter of this book, expanding or contracting the flow of public
investment in local economies is in some ways the most important
tool available to Gulf leaders in managing through crises and
recessions.