Christine Lagarde, managing director of the International Monetary Fund, paid a visit to the United Arab Emirates this week.

Market Watch Blog AGSIW | Karen E. Young | Feb 26, 2016

Christine Lagarde, managing director of the International Monetary Fund, paid a visitto the United Arab Emirates this week. She was invited as a keynote speaker and participant at two showcase events on economic development in the region: the Arab Fiscal Forum, organized by the Arab Monetary Fund with the IMF, and the Global Women’s Forum in Dubai, a group committed to promoting women’s participation and leadership in the private sector. In her public remarks, Lagarde made the case for tax implementation in the Arab Gulf states. At a joint press conference after her speech to the Arab Monetary Fund, UAE Minister of State for Financial Affairs Obaid Humaid al-Tayer announced that the UAE would implement a value added tax of 5 percent on goods and services (with some exceptions for essential food items, health care, and education) by 2018.

The IMF can be a useful foil for governments seeking to implement fiscal and monetary policy reform packages. Negotiations between the IMF and countries receiving stabilization packages, usually with injections of foreign exchange to their central banks in exchange for liberal economic reforms and repayment with interest, often include a photo op and interview session in which the receiving government plays good cop to the IMF’s bad cop role. Governments sometimes use the IMF to justify to citizens why they must face reduced public salaries or pensions, or a difficult devaluation of their currency. Robert Wade’s work on East Asia has demonstrated how the advisory role of international financial institutions has political and ideological bases. The prescription for reform usually involves a trade off in which citizens must be convinced that the medicine tastes bad, but will fix the sickness in the economy.

The IMF’s relations with the Arab Gulf states are an interesting revision of the historical relationship between a state-led growth model and the Washington Consensus for liberal economic reforms. The IMF has zero leverage with Gulf Cooperation Council states. There is no IMF intervention, loan package, or bail out in any of the GCC states. These are wealthy states that, with their quota contributions to the fund, help poorer states in balance of payment crises.

The amiable joint press conference between Lagarde and Tayer displayed the policy advocacy role the IMF continues to enjoy, but it also revealed the usefulness of the international financial institution to Gulf states. While the IMF continues to advise the GCC to consider reducing subsidies in energy and introducing taxation, it is the state’s management of the reform process that prevails. The invitation to Lagarde came at a time when the Gulf states themselves have decided to press forward with the idea of a value added tax.

It is no secret that introducing taxes would raise state revenue; it is an easy fix. However, the GCC has made a habit of threatening taxes over the last decade. The last discussion in 2008 was quickly abandoned in the midst of the global financial crisis. For the GCC, the diagnosis of the illness still rests with the state, not the IMF, or even international capital markets.

The GCC will hold together and serve as a regional lender of last resort. This is a regional organization that has taken care of its own. The case of Bahrain has already shown that reliance on regional allies, through the GCC Development Fund’s $10 billion fund for infrastructure, can at least sustain some (albeit sharply reduced) levels of government spending. Cash injections to GCC central banks are also likely, though there will be less to share.

A reliance on foreign exchange reserves is a safe short-term strategy for balance of payments problems, as well as shifting relief to Gulf domestic bank sectors. Saudi Arabia’s foreign currency reserves remain very strong at over $600 billion. The long-term effects will put pressure on local currency pegs and could also affect Gulf states’ ability to raise capital in debt markets, but these remain in the future. If and when Saudi Arabia taps international debt markets could be a better bellwether of the state of regional monetary policy.

The GCC may not always be an effective organization at coordinating fiscal and monetary policy. However, it is an effective organization at sharing resources and supporting its weaker members, often on the basis of personal relationships and loyalty rather than a committment to economic theory or ideology.

This article was originally published by the Arab Gulf States Institute in Washington (AGSIW)

Dr Karen E Young is a former senior resident scholar at the AGSIW. She is a resident scholar at the American Enterprise Institute in Washington and a senior advisor at Castlereagh Associates.