A project to establish a common currency for the Gulf has been dealt a near-fatal blow with the decision by the United Arab Emirates to abandon monetary union after disagreement with Saudi Arabia over the location of a future central bank.

The loss of the Emirates to the currency project could accelerate decisions within some Gulf states to diverge from Saudi Arabia’s desire to maintain a currency peg with the dollar. This could lead eventually to the UAE, the Gulf’s most sophisticated economy, floating its dirham, analysts in the region said.

The UAE attributed its decision to quit the Gulf Cooperation Council (GCC) project to the choice of Saudi Arabia as host of the key monetary institution.

Evidence of mounting rivalry and distrust between the Gulf’s two biggest economies emerged two weeks ago, when a meeting of the GCC voted to locate the central bank in Riyadh. UAE officials expressed reservations about the decision. The choice of Riyadh would enhance the physical presence of Saudi Arabia within the GCC, as the organisation’s secretariat is already headquartered in the Saudi capital.

The UAE is the second state in the six-member GCC to pull out of the common currency, which was due to be launched next year. Oman had said already that it would not take part, but the loss of the Emirates, which has the greatest international trading links, makes it unlikely that the project will get off the ground.

Officials in the Gulf said that the remaining states – Bahrain, Kuwait, Saudi Arabia and Qatar – remained committed to monetary union. However, tensions within the group were exacerbated in 2007 when Kuwait cut its currency loose from the US dollar, preferring to float its dinar against a basket of currencies. The Kuwaiti move put it at odds with the other GCC states, which peg their currencies to the dollar.

Behind the dispute over the location of the central bank lies a more profound disquiet within the UAE over increasing Saudi power within the GCC. Marios Maratheftis, regional head of research at Standard Chartered in Dubai, said: “There is a presumption that Saudi Arabia, being the largest economy, would dominate policymaking in the central bank.”

Saudi Arabia’s economy represents almost half the combined economic weight of the GCC group of states. The GCC’s common currency project was founded in 2001, when the six states set themselves on a path towards an economic union, initially forging a customs union and a common market with the objective of monetary union by 2010.

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