Download Effects of a unified GCC currency

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Prince Mohammed Bin Fahad University
Effects of common currency for gulf countries
Student Name Ibrahim Al-Gusaier
200600005
Course Name Money and Banking
Prepared to Dr. Mohammed Magablah
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Introduction
The member states within the Arabian Gulf have been working out to create an
association and corporation that will see them expand economically. One factor that shall
catalyze development is the idea of a common currency within the Arab member countries.
Common currency system is prominently associated with economic and political factors; for
example, the trading blocks (economic) and federal governments like the United States of
America, European countries and now, Gulf States. The social factor aspect is usually minimal
and at times negligible. Some of the major trading blocks include: ECOWAS, EU, COMESA
and EAC. Some of the above blocks have already established common currencies. The author
chose to undertake this research for the motive that in doing so; hopefully, it will help the GCC
region countries to fully comprehend the consequences of fully adopting a common currency in
the region. It will also assist the other blocs in deciding whether to adopt a single currency
through its findings.
Effects of a unified GCC currency
There are both positive and negative effects of the GCC push for a common currency.
The success or failure will depend on the institutional framework design by the bloc’s members.
A monetary union’s success is highly dependent upon the uniting factors that exist within the
bloc. Among the monetary unions that exist in the world, the GCC is described as being the
“most homogenous” (Khan, 2009, p. 2). The GCC countries share a common history, culture and
language. All the GCC countries, with the exception of Bahrain, are mainly oil exporters, are
open to imported labor and trade, have self adjusting labour markets and are characterized by
unrestricted factor mobility within the region. Much progress has been achieved towards the
attaining of a single currency.
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Exchange rate uncertainty
According to Al-Shammari (2007, p. 15), in the event that two member countries have to
make a cross border sale agreement of a commodity, the exchange rate volatility will cause a
major hindrance to the trade. A decline in one nation’s relative to the other has the implication of
reducing the amount which the exporter will get for his commodity i.e. the importer of the
commodity will end up paying less than should have been paid. This means that the countries
have to look for techniques to avoid the exchange rate volatility so as to enhance international
trade. An experiment of the European Union indicated that had previously maintained low
exchange rate volatility before the establishing of the European Monetary Union (EMU). This
was due to the fact that they formed the European Monetary System in 1979 that enhanced the
stabilization of the exchange rate fluctuation on behalf of the member countries. The GCC
countries have maintained stability in their individual currencies in relation to the US dollar and
among themselves.
Laabas & Limam (2002, p. 4) state that the adoption of a common currency will enhance
fixed exchange rates and as a result, reduce the uncertainty that is an obstacle to trade and
investment. Costs of monitoring currency fluctuations, cost of predicting exchange rate
movement, currency conversion costs and the costs to maintain reserves for intra-regional trade
are all eliminated. The GCC associate states officially pegged their local currencies to the US
dollar in the year 2003, as an explicit stride in attaining monetary integration (Khan, 2009, p. 2).
This decision was largely based on the expectation that the dollar would remain stable and
strengthen the confidence in the countries, and as a result, the countries would go into the union
at those particular similarities. This has led to member states pursuing economic strategies that
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are in line with the exchange rates pegs. An example is the adjustment by countries in
implementing necessary fiscal policies and enhancing flexible labor and commodity markets.
Elimination of transaction costs
The desire by the GCC countries to forge a single currency is driven by their perception
that the full integration of the product and factor markets will require the complete removal of
transaction costs and other uncertainties that are linked to the use of separate currencies (Aleisaa
& Hammoudeh, 2010, p. 6; Laabas & Limam, 2002, p. 3). The elimination of these transaction
costs will have the implication of lowering the magnitude of prices discrimination in the market.
Also, the GCC region will influence gains from efficiency as a result of improved trade and
enhanced capital flows stemming from the elimination of the transaction costs and discarding of
multiple currencies.
According to (Al-Shammari, 2007, p. 17), trade costs are attributed to two main causes:
currency conversion for international trade and the need to evade uncertainty, which can lead to
adverse effects on trade and investments. The adoption of a common currency reduces the fee
paid by both individuals and companies to the financial segments situated in the various
countries in the GCC region.
The adoption of a single currency would be of immense benefit to the GCC region.
Haseeb & Makdisi (1982, p. 385) outlined the potential benefits as follows:
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A joint currency would clear the way for a full economic integration. The states are fully
conscious of the value of the Gulf unity in diverse areas, since the conditions are
favourable for cooperative activity that would be of monetary benefits.
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The government sector has a crucial role to play in the economic development of individual
members states. The adoption of a common currency would have the impact of enhancing
joint management, which would in turn allow for coordination of investment strategies.
This is considered an important step in the process of achieving a full economic integration,
primarily due to the fact that the productive bases of the region are weak and would work
better as a unit.
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A common currency would pave way for the establishing of a common capital market, the
adoption of joint economic legislation and the coordination of monetary policies. Though it
is evident that the countries have not yet decided on the inclination of their productive
bases, the resultant economic coordination would assist them in avoiding the establishing
of similar industries which would lead to misallocation of monetary resources.
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Currently, the GCC currencies are robust due to the reserves backing them up. The
adoption of a single currency would imply an even stronger currency which would be more
stable than the individual currencies. This means that the common currency would be a
strong international currency that would be more willingly accepted than a domestic
currency.
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The flow of investment from the surplus nations to the deficit countries of the Arab world
would be enhanced by the adoption of a common currency.
Effects on the US dollar
The GCC region is highly dependent on oil exports, though the GCC is trying to enhance
diversity in member states’ economies (Phillips, 2008). It is the goal of the GCC to improve the
private sector participation in intra-regional economic development. The GCC envisions a
number of benefits from the adoption of a common currency. For instance, an increase in the
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intra-regional trade will contribute to an increased participation by private investors which will,
in turn, led to a soaring in the demand for non-oil related commodities in the region. The
elimination of transaction costs will lead to the growth of other areas, other than that of oilrelated products, and to general economic growth.
Initial expectations were that the common currency would pegged on the US dollar.
Although the GCC has to decide on how to value the common currency, there is a possibility of
excluding the dollar from oil pricing. This would mean that the US would be hit by inflation.
This would affect the GCC region too, as it holds assets in the US that are worth approximately
$2.0 trillion, which are dollar dominated. According to Phillips (2008), the IMF stated that a 20
percent reevaluation against the US dollar would mean a $400 billion loss on all external, dollar
dominated assets. As much as it would damage the dollar demand, member states risk losing
value on their assets, leading to them undertaking studies on how to value the common currency
while minimizing chances for loss.
Economies of scale and simplicity in comparison
A single currency will enable the GCC countries to easily compare the prices of
commodities across country borders, since the geographical boundaries are eliminated in a
common market. This will contribute to effective competition and abolishment of any kind of
monopolistic tendencies. The increase of competition has the implication of bringing benefits to
consumers in the form of lower prices for similar commodities across the countries. Also,
flexibility of prices will be enhanced due to the fact that suppliers of commodities will not
possess the power of setting market prices for their products. A common currency facilitates
healthy regional competition in the banking and fiscal sectors, as well as the quality of services
offered, which will be advantageous to the GCC customers; this leads to a reduction of costs and,
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subsequently, to the differentiation of services, ultimately leading to a full blown amalgamation
of institutions across the regional bloc to take advantage of the size of economies (AlKholifey &
Alreshan, 2010, p. 23).
Release, partially, of foreign exchange reserves
The move towards a single currency will have the implication of GCC companies paying
using the new currency, meaning that central banks of member states will not have to hold a part
of the foreign exchange reserves to settle regional trade transactions (AlKholifey & Alreshan,
2010, p. 23).
Al-Shammari (2007, p. 7) cites the disadvantages of adopting a common currency by the
GCC as “loss of monetary policy autonomy, and the loss of national central bank independence.”
AlKholifey & Alreshan (2010, p. 23) concur, stating that the GCC countries will yield their
control on the “exchange rate and monetary policy instruments.” In the event that an individual
country gives up its national currency, it also surrenders its capacity to carry out a monetary
policy. A monetary union does not permit national central banks to take the initiative of
manipulating the exchange rate of the common currency or alter the interest rate. These decisions
are left to the newly established regional central bank. Aleisaa & Hammoudeh (2010, p. 6) are of
the view that adoption of a single currency would reduce the policy independence of member
states from formulation and implementation of nation-specific monetary and fiscal policies as a
solution to nation-specific problems.
A lack of fiscal prudence in one or several member states of the GCC presents a risk of
negative externalities. According to Schaechter (2003, p. 21), a negative externality has the
potential of spilling over into the rest of the member states, causing financial recession, as the
intra-regional central bank will have to raise the interest rate charged, especially in the exchange
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rate hinged on the common currency. This raises the challenge of coming up with rules,
institutional processes and penalties to hinder massive macroeconomic imbalances and lack of
monetary discipline in the GCC. Meticulous macroeconomic policy formulation is an integral
component of monetary unions.
Findings
A common currency would play a major role in regional market stability of the
member states. It would also enhance the understanding and cooperation among the member
states; stimulate growth through trade barrier elimination and monitor currency volatility. In
other words, common currency has a direct link with the usual socio-economic and political
factors influencing any significant money market.
Implication
Common currency would normally work when countries, involved, have similar
economic position. Their resources have to provide similar GDP’s and their individual income
should match within close proximity. They should be complimenting each other in these
resources. The problem that faces the GCC is that most of them are rich in one resource oil, and
they are all lacking most of the other resources. The other area which adds to the problem is the
different political structure. Kuwait, for example, has a parliament which has to support any
decision the counsel would want to implement.
Conclusions
The research shows that benefits of adopting a single currency by the GCC states
outweigh the adverse externalities. The benefits of a common currency are considered as being
long term, with the costs expected to be experienced immediately. In the long run, a common
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currency might have the implication of bolstering trade and investment within the GCC, and may
also help to reduce national differences and attain a union in economic policy in the future.
However, the realization of these objectives is hinged upon the features of the countries in the
GCC, in addition to their competency in adjusting to the changes.
It is evident that the adoption of a common currency would have much more profound
positive effects on the GCC countries, as opposed to the adverse effects. It would therefore be
prudent for the GCC to abolish their existing currencies and implement a single currency for the
bloc. However, more extensive research needs to be undertaken on the implication of the single
currency on individual sectors in each of the GCC countries to fully realize the consequences of
the single currency, which this research could not effectively carry out due to limited time, funds
and complexity of the survey.
Following a thorough study on the feasibility of the findings which was tested by
questioning a large group of people, it was concluded that a common currency may provide a
solution to the economic stability of the region. It could provide the seed for further unities like
common passports, common courts, and common rights. The US is an excellent example for a
target setup. Much remains to be done in individual countries to achieve the benefits that the
single currency would bring. It is the hope of the author that the GCC countries, as well as other
researchers, will find this proposal helpful as a benchmark in carrying out further studies
pertaining to this topic.
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3. References
AlKholifey, A., & Alreshan, A. (2010). GCC monetary union. IFC Bulletin No 32 , 17-51.
Al-Shammari, N. N. (2007). Exchange Rate Policy and International Trade Linkages and
Impacts. Syracuse : ProQuest.
Aleisaa, E. A., & Hammoudeh, S. (2010). A Common Currency Peg in the GCC Area: The
Optimal Choice of Exchange Rate Regime. Middle East Economic Association volume 9 ,
1-22.
Erbas, S. (2003). Exchange Rate Regime Consideration for the Gulf region. Washington: IMF.
Haseeb, K., & Makdisi, S. A. (1982). Arab Monetary Integration: Issues and Prerequisites. New
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Khan, M. (2009). The GCC Monetary Union: Exchange Rate Regime. Washington: Peterson
Institute.
Laabas, B., & Limam, I. (2002). Are GCC Countries Ready for Currency Union? Kuwait: Arab
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Sturm, M. (2005). Regional Monetary Integration: GCC case. Frankfurt: European Central
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Schaechter, A. (2003). Potential Benefits and Costs of a Common Currency for GCC Countries.
In U. Fasano-Filho, & A. Schaechter, Monetary Union Among Member Countries of the
Gulf Cooperation Council (pp. 16-45). Washington DC: International Monetary Fund.
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Tomasi, W. (2009). What is common in The Arabs world? The Economist, Jul 23rd
2009.
Xuequan, M. (2011). GCC welcomes Jordan. Retrieved November 17th 2012 from:
http://news.xinhuanet.com/english2010/world/2011-05/11/c_13868474.htm
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