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Whither the euro? How will financial developments in Europe impact upon the oil-producing Gulf states whose currencies are pegged to the US dollar?

The EU Summit in Brussels at the end of March may have temporarily resolved some of the issues surrounding Greece's huge sovereign debts, but it also exposed the difficulties Eurozone leaders have had in taking timely action on their own. The result: questions will continue to be raised in global markets about the future of the euro, especially with more problems looming ahead in countries such as Spain and Portugal, Ireland and Italy.

In the Gulf states, most of whose currencies are still completely pegged to the US dollar, the precipitate decline in the euro over the past 10 months will be welcomed by some. After all, it makes imports from the Eurozone, such as capital goods, pharmaceuticals, foodstuffs, electronic goods and services--not to mention BMWs, Prada bags and Cartier watches--much cheaper. And, given that the largest share of GCC imports comes from Europe, that in turn also helps keep a lid on inflation, a fact which will be even more welcome as the Gulf states start to recover and expand rapidly.


But a falling euro also angers many in the US, who see this as a challenge to the not-so-hidden efforts of Washington to talk down the dollar and to keep interest rates low as a means of gaining more global competitiveness in trade, particularly against Europe. Such policies also help to prop up the jobs markets by promoting American exports.

Growing unrest

They are not alone. What, one wonders, is the view of those sitting in their offices at the sovereign wealth funds of Abu Dhabi, Kuwait, Qatar or Bahrain? While a declining euro-dollar exchange rate may bring down the cost of buying property or shares in Europe, this assumes that price is a main concern, which it is not, given the long-term interests of such funds. Instead, it stands to wreak havoc with their massive existing investments in the US, should a strong dollar weaken US economic recovery, exacerbate the country's mountain of debt and spur a new round of inflation.

Pledges by US Treasury Secretary Tim Geithner last summer to support a strong dollar were seen as shallow at the time, belying, in fact, domestic policies that favoured the opposite. Now, the euro's volatility vis-a-vis the greenback seems simply to point, yet again, to Washington's growing inability to influence the value of its currency on the global stage.

Proposals at Brussels to set up a European Monetary Fund and to work with the Washington-based International Monetary Fund may have assuaged some of the euro's sharpest critics. But German Chancellor Angela Merkel's determination to rewrite European treaty provisions to avoid another potential default like that raised in the case of Greece--and to ensure that all 16 members of the Eurozone comply with the rules on budget and fiscal prudence--is likely to exacerbate further the divisions already existing in the EU over its combined currency.

Which of the member states will agree to the kind of surveillance that Germany has in mind? As one Greek official said, "We will have a German under every desk," a view which many of his countrymen in that ancient land will find repugnant given the memories of Hitler's occupation. And, then again, which of the member states will be willing to pay for another bail-out, should the need arise now or in the future? Will Germany again be expected to pick up the biggest share of the burden?

The former German vice-chancellor and foreign minister, Joschka Fischer, warned earlier this year that Europe was facing the dilemma, "Pay for the southern European countries or resign oneself to the end of the euro." Once celebrated as 'Ms Europe', Merkel, he argued, "was looking more like 'Frau Germania'." While the agreement reached in March put paid to some of those fears, it is not yet clear which Merkel will be on display should Greece fail to raise the $20-plus billion it needs by the end of May or if other Eurozone members also go cap in hand to Brussels.

Equally experienced experts say that without further economic and political integration, the euro will continue to experience some sharp wobbles that will undermine the confidence not only of international investors but also of Europe's would-be partners, including those in the southern and eastern Mediterranean. Growing social and political unrest in some of the member states is already adding to these concerns. And a break-up of the Eurozone, or withdrawal of one of its members, while unlikely, cannot be ruled out.


Stagnant economy

As Nasser Saidi, Chief Economist of the Dubai International Financial Centre, wrote in early March, "The EU will need to impose strict fiscal rules beyond Maastricht and move towards an EU government structure with a unified fiscal policy. Retirement ages," he insisted, "should be raised to 70 or 75 and new institutions will be required such as a European Monetary Fund able to intervene and provide adjustment financing for countries facing financial difficulties."

His views are shared by Nouriel Roubini, the US economist and New York University professor who predicted the housing meltdown as early as 2005. He pointed out earlier this year that "No currency union has survived without a fiscal and political union." This is still lacking in the Eurozone, and the deep divisions over what to do with its more profligate participants will make achieving that union even more difficult.

Meanwhile, the issue of how Europe's leaders deal with the need to rescue their stagnant economies will come more to the fore, just as the issue of sovereign debt did in the wake of the Dubai financial crisis. Pouring more money into fiscal stimulus packages is not on the agenda; indeed most of the stimuli of the past two years are being withdrawn, thereby threatening the fragile recovery.

The euro will continue to suffer the swings and roundabouts of this process. And while the dollar may find favour at the moment, any further upheavals in Europe could see investors forsaking it again in favour of gold, despite its apparent strength. What's more, threats to European economic recovery will have a direct affect on the price of crude oil.

While the Gulf's expected return to more normal growth levels this year and next is unlikely to be threatened, investors, whether public or private, as well as the region's companies and households, have little to gain, in the end, from a growing disparity between the euro and the dollar.

And, by the way, let's have no more of those warnings from Europe sabout the GCC's failure to achieve a fully fledged currency union of its own. But then, let's hope, too, that Gulf leaders learn the lessons of Brussels' current agony.
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Title Annotation:BUSINESS
Comment:Whither the euro? How will financial developments in Europe impact upon the oil-producing Gulf states whose currencies are pegged to the US dollar?(BUSINESS)
Author:Smith, Pamela Ann
Publication:The Middle East
Geographic Code:7UNIT
Date:May 1, 2010
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