Building upon the European model of Euro, the GCC is planning to introduce a common currency Khaleeji around 2010 for its member states. The Euro brought several benefits to its member states and observers have similar expectations from the Khaleeji. Some of the benefits are
Increased Investment
From the European experiment, it is evident that a singular currency increases intra-region trade. Thus the GCC member states would experience heightened regional investment which can be critical in the current financial crisis. At a time when international investment is shying away from the Gulf, this has become vitally important. A recent example is the severe economic crises resulting from the debt rescheduling request from Dubai world which had a major impact on the financial markets of the Gulf. However, when the Abu Dhabi government announced plans to bail out Dubai World, financial stability was witnessed throughout the region. This shows how important intra-regional financial backing is.
Increased trade
With the advent of the Euro, Europe has witnessed increased intra-regional trade. This is not surprising because shrewd businesses realize that doing business within the same region reduces their transportation costs as well as shields them from the possible losses of converting into different currency before trading. When a business concern of one country would have the ease of trading in the same currency with a business concern of another country, it would be very easy to negotiate the terms and conditions of the deal.
Protection from exchange rate risk
When countries trade in different currencies, they are inevitably exposed to exchange rate risk. Exchange rate risk is the risk that results from fluctuations in the value of a currency relative to another. For example if one trader from Europe purchases a product from a trader in USA and the dollar decreases in value to the Euro, then the seller would have to pay more dollars than he would have under previous conditions. Similarly, if the transaction has completed and the dollar depreciates after that, the seller would have made a profit but the buyer would have incurred a loss because the value of dollars has decreased. If both traders had a similar currency, there wouldnt have been any such risk. While such risk might seem minor, it should be kept in mind that inter-country transactions are often high-valued and even slight fluctuations in the exchange rates can have a significant impact on the earnings.
Positive impact on interest rates
The interest rates in Europe have decreased as a result of the Euro. This helps in several ways it increases the worth of businesses in countries that previously had a weaker currency and it boosts their business activity. With lower interest rates, the cost of doing business would decrease in the GCC member states thereby boosting economic activity.
Positive impact on intra-regional tourism
The Euro resulted in increased tourism in the European Union. If the same happens in the GCC, it would provide significant relief to the present tourist industry of the GCC which relies heavily on international tourists from Europe and America. If the GCC member states succeed in boosting intra-regional tourism with the introduction of a singular currency, they wont be affected in times of global financial crises much like the current situation in the GCC.
Similarly, there are several disadvantages of a single currency which the GCC member states must be wary of in light of the lessons drawn from the European initiative of a single currency. Some of these disadvantages are as follows
Cost of transitioning
The initial hitch in converting an entire region on a single currency is the cost of this transition. This cost includes the unification of accounting standards, changing meters throughout the region, training personnel in the use of the new currency and all sorts of software and systems in use in different countries of the region. This is a formidable cost that must be taken into account before any decision on the unification of the currency in GCC member states is taken.
Interest Rate adjustments
Traditionally, one of the most favorite tools of boosting economic activity in a country has been the adjustment of the interest rate. When governments felt that they need to boost economic activity, they would lower interest rates. With a singular currency, this would no longer be possible.
Exchange rate adjustments
Another tool of boosting economy has been the adjustments in exchange rate. When a currency is devalued, its exports become cheaper thereby increasing the international demand for its products. This boosts export oriented economic activity within a country. This ability to adjust exchange rates would also be foregone by the GCC member states as a result of the Khaleeji.
Fixed floating rate is when the value of a currency is tied to another currency or asset (such as gold) and floating exchange rate is when the value of a currency is set according to the supply and demand of that currency in the Foreign Exchange markets. While currently the UAE and GCC member states are following fixed exchange rate system, a singular currency would lead to a floating exchange rate system. The fixed floating rate provides individual governments greater control over their currency and offers importers and exporter greater certainty of value. Apart from that a fixed exchange rate system effectively eliminates the element of speculation. The major disadvantage of a fixed exchange rate system is that a reserve currency has to be maintained in order to maintain the exchange rate. The reserve currency represents an opportunity cost as the same money could have been utilized elsewhere.
A floating exchange rate has the major benefit of automatically adjusting to the economic scenario. For example, if the economic conditions in the GCC deteriorate and the Khaleeji is being used, the floating exchange rate would automatically reduce the value of the Khaleeji thereby automatically making the exports of GCC member states cheaper. However, it would also increase uncertainty in the GCC member states as the price of the Khaleeji would be subject to day-to-day adjustments according to supply and demand. As speculation is characteristic of the floating exchange rate system, it can also have an inflationary affect.
Comparison of Euro and Khaleeji
Both promote regional trade
Both have floating exchange rate
Both reduce speculation in monetary marketssupply and demand would determine the value of the currency
Both would reduce dependence on foreign exchange reserves
Both currencies have been marred by political issuesBritain in Europe and UAE in the Gulf have reservations on the common currency
Both would promote tourism
Both would help shield their respective regions from external shocks
The Khaleeji has unfortunately been fraught with political wrangling between the member states. There is a conflict over who would host the central bank, with the UAE and Saudi Arabia both contending for the prestigious position. This is why the UAE has currently backed out of embracing the singular currency regime. The future however looks full of opportunities for the GCC member states. If they somehow overcome their political differences, they could fast track the process of economic integration and emerge as a formidable economic power of the world. They could become more insulated to global economic shocks and they can increase the overall prosperity of the Gulf.