GCC and the Currency Union The Next EU
The GCC, formed in 1981 by six Arab states, is an economic power holding about half of the worlds oil reserves and a fifth of gas reserves.
The GCC and a currency union are a perfect match.
A currency union is the use of a single currency across a region having the same monetary policies under one administration. The Euro serves as the best example of a successful use of a currency union.
The impacts of a currency union to a regions economy range from elimination of currency exchange risks, promotion of regional competitiveness, trade enhancement, investment and tourism, corporate health and expansion improvement and encourages financial discipline and transparency. Costs of having one may include losing national monetary, fiscal and exchange rate policies.
Looking into the traditional measures of OCA (optimum currency area), GCC may well be the next European Union.
Being prepared for a shift to a currency union requires the establishment of institutions that will push forth the realization of a single workable currency.
GCC shares a homogeneous cultural experience and history. The success of a currency union is imminent given the regions economic soundness and healthy politics. Dangers that lurk, i.e. China and the Greek crisis, must be addressed through a political union, an important monetary union prerogative.
With the success of the European Union, a monetary union with a single currency in a region bordered by the East and the West is a long time coming. It will be the new face of economic development and political dynamism.
The GCC Monetary and Economic Union
On May 25, 1981, Bahrain, Oman, Kuwait, Qatar, Saudi Arabia and UAE formed the Cooperation Council for the Arab States of the Gulf or GCC (Laabas and Limam, 2002). The GCC now holds 45 percent of the worlds proven oil reserves and 17 percent gas reserves (Fasano, 2003) making it a global economic powerhouse. Relevant to the establishment of this regional bloc was the achievement of economic cooperation and integration, which was outlined in the GCC Charter and Economic Agreement 1981 (Cooperation Council for the Arab States of the Gulf SG, n.d.). The push towards a unified region of interdependent nations was clear in the GCCs Economic Agreement. Provided in Article (22) of the said agreement, it says
Member States shall coordinate their financial, monetary and banking policies and increase cooperation among the Monetary Agencies and Central Banks, including unification of currency to support the anticipated economic integration among them (Cooperation Council for the Arab States of the Gulf SG, n.d.).
After talks about a monetary union and a single currency were postponed in the nineties, the Bahrain Summit of December 2000 re-discussed the issue with he US dollar chosen as a common peg (Cooperation Council for the Arab States of the Gulf SG, n.d.). To realize the common currency or currency union, a monetary union must first be formed. Below is a timetable of the formation of the Monetary Union (per GCC-SG online publication)
The Supreme Council in December 2001 approved the timetable for establishing the union.
Schedule also required the members to maintain a level of economic performance relevant to convergence criteria (i.e. monetary union by 2005) and eventually a single currency by January 2010. Per GCC-SG
For the purpose of achieving the GCC Monetary and Economic Union including introduction of the single currency, Member States shall meet the requirements of that union, according to a specific time schedule, and achieve a high level of convergence among Member States in all economic policies, particularly the financial and monetary policies and the banking legislation, and develop criteria to ensure proximity of the significant economic performance averages for achieving financial and monetary stability, such as deficit rates, indebtedness and rates.
At the 26th Session in Abu Dhabi December 2005, two convergence criteria were set to be followed (a) the monetary convergence criteria inflation rates, interest rates and sufficiency of the foreign cash reserves, and the (b) financial convergence criteria annual deficit ratio of the government finance to GNP and the ratio of the public debt to GNP.
At the 28th Session in Doha December 2007, newer instructions for alternatives in managing the proposed single currency through a monetary authority were proposed.
GCC and Currency Union A Perfect Match
A currency union is the use of a single currency across a region having same monetary policies under one administration. The proposed Gulf currency, dubbed as Gulfo, will use this petro-currency of their own displacing the US dollar as the pricing currency for their oil contracts (Evans-Pritchard, 2010).
The impacts of having a currency union are wide as they are varied. It is projected that benefits will be observed on intra-GCC Trade, tourism and investment, exchange currency risks of the GCC states will be eliminated and will improve stock markets mergers or procure corporations within the GCC will be encouraged regional competitiveness will be promoted and lastly there will be an enhanced transparency and financial discipline in the region (Cooperation Council for the Arab States of the Gulf SG, n.d.).
Fasano (2003) seconded these benefits saying that the move towards a monetary union should improve the efficiency of financial services, lower transaction costs, and increase transparency in prices of goods and services, and thereby facilitate appropriate investment decisions. In the words of Tenreyro and Barro (2002) theoretically, a currency union enhances trade, increases price co-movements, and decreases co-movement of shocks to real GDP (consistent with the view that currency unions lead to greater specialization). They further reiterated that it also leads to better consumption behavior and production decisions.
Costs of a monetary union are a loss of national monetary and exchange rate policies, as well as changes in economic structures and trade patterns may lead to different growth and inflation effects and fiscal policies, especially incentive policies, may create unfair competition (Fasano, 2003).
The OCA (Optimum Currency Area) Criteria
Laabas and Limam (2002) argue that the GCC is yet to fulfil the traditional optimal currency area (OCA) criteria, as the structure of economies in the Gulf is still oil-dominated with limited intra-regional trade. They further describe the OCA as a region where it is optimal to have its own currency and its own monetary policy. OCA would allow exchange rates to be fixed because multiple exchange rates have high transaction costs (costs to predict exchange rate movements, cost of convert currency, and cost to manage reserves for intra-regional trade) (Laabas and Limam, 2002).
The OCA criteria include openness, factor mobility, degree of commodity diversification, similarity of production structure, price and wage flexibility, similarity of inflation rates, degree of policy integration, and political factors. It is important to analyze these criteria one by one to prove that the GCC is ready for monetary union through a single currency.
Openness. GCC is not ready as most goods are tradable (oil as main product). The exchange rate is an ineffective corrective tool due to inelastic demand for imports. (Laabas and Limam, 2002). Countries that are highly dependent on trade like the GCC will be easily affected by external shocks.
Factor Mobility. Factor mobility serves as a substitute for exchange rates to correct shocks. GCC was still not on labor (Laabas and Limam, 2002). However, eight years later after Laabas and Limam study, GCC labor markets were analysed as flexible (i.e.labor can move freely), although two-thirds of its labor force are foreign (subject to complex visa procedures) (Razzak, 2010). Razzak further points out that most locals work for the government so it is unlikely that they will leave their jobs. But according to Pugel and Lindert (2002), the EU experience actually did not meet this criterion when it first started because labor mobility across borders was low even within the EU countries. On this measure, GCC is ahead of the EU.
Degree of Commodity Diversification. Diversified economies are better at facing shocks and other terms of trade. GCC is still heavily dependent on oil and it does not use the exchange rate as a policy adjustment instrument but through government expenditures (Laabas and Limam, 2002). To compensate for lack of diversified intra-industry trade, specialization and sophistication of industries are viable solutions (Laabas and Limam, 2002).
Similarity of Production Structure. A common production structure often led member states to experience symmetric shocks. GCC has it as oil dominates its production processes (Laabas and Limam, 2002).
Price and Wage Flexibility. Although there is limited flexibility of prices and wage, GCC is still fit to qualify for a currency union (Laabas and Limam, 2002). With price of oil tied to international changes in price, all domestic prices, including the price of labor, would tend to fluctuate with the changes in oil price.
Similarity of Inflation Rates. Inflation rates are pro-cyclical picking pace during oil price hikes and decreasing during slumps (Laabas and Limam, 2002). All countries of the gulf having to export almost the same product - oil and oil-based products- inflation rates would behave similarly.
Degree of Policy Integration. The same policy attitudes can be seen per Article 4 of GCC charter (Laabas and Limam, 2002). As stipulated in their 1981 Economic Agreement, it is expected that the member countries will share the same policies for the common good.
Political Factors. Political factors might be more important than economic criteria, experience says. GCC is very committed. It is praised for taking pragmatic approaches towards integration (Laabas and Limam, 2002).
According to the analysis of Laabas and Limam (2002), GCC met five of the eight criteria (4, 5, 6, 7, 8) in the OCA eligibility test. However, it is yet to fulfil some pre-conditions to be fully currency union-ready (I.e. intra-regional trade) (Laabas and Limam, 2002). Six of eight as improvements in factor mobility especially on labor have given the GCC an upper hand in their quest for a unified currency. But deep in their analysis, they made a comment on the eligibility test basing on the European Unions history. It showed many EU member countries did not meet the criteria at the beginning. The OCA criteria are also argued as generally met ex post rather than ex ante(Laabas and Limam, 2002).
The Power of Political Will
To develop as a region with one monetary authority and one currency, a policy mix of decentralized fiscal policies and a centralized monetary approach are expected (Fasano, 2003). Having a decentralized supranational monetary authority, a common central bank and national central banks will only require a stronger fiscal policy and political will (Fasano, 2003). Laabas and Limam (2002) argue that a commitment to a fixed exchange rate system and a strong political resolve are the factors to consider for a favourable currency union. Like the ECB, which is independent from national political influence and cannot accept or seek instructions from national governments (Dornbusch, Fischer, and Startz, 1998), the proposed central authority must also be politically correct in its decisions.
Looking Ahead
There are concerns that the region is trying to run before it can walk (Evans-Pritchard, 2010). The euro is the GCCs model. Europe took 40 years to this point, taking 11 years for the coins and notes to reach the deepest of streets (Evans-Pritchard, 2010). It may be seen as something premature but taking into consideration the relative preparedness of the GCC as analysed by the OCA criteria, the EU seemed to be less prepared when it decided to merge into one monetary group. The EU took slow steps because they have more countries to take into account. The sixteen current members (which will soon become 18) took decades to be part of it. The GCC only expects six at the start. That is a lot easier to manage given the fact that, as Evans-Pritchard (2010) points out, the logic of an Arab currency union is composed of three tenets one language, one Koran, and has not disintegrated in wars. GCC shares a remarkable degree of cultural and political homogeneity (Fasano, 2003).
As stated above, GCC motivation and commitment are clear and present. Now, to address the current problems and systemic failures, natural or artificial, the group must first need a commission, a court, and a bank (Evans-Pritchard, 2010). With these institutions, GCC will be able to break down basic barriers to trade and capital flows- its main problem as shown in the OCA test. By reducing domestic market segmentation and strengthening national labor laws and policies (expatriate versus local), while ensuring a smooth flow of cross-border workers from the member states (Fasano, 2003), this can be directly treated. As countries adjust to the fixed exchange rate of a monetary union, this will be controlled and removed as a deterrent factor. This should not be difficult as current real (flexible) exchange rates in GCC are closely related, sharing the same stochastic trend (Laabas and Limam, 2002). With this striking similarity, the GCC has in effect been exercising a somewhat fixed exchange rate in its monetary transactions long before it decided to have a single currency.
Other threats will still exist, nevertheless. The Saudi dominance has been seen by critics ever since the plan of a monetary union was brought up. Saudia Arabia may dominate the currency (Evans-Pritchard, 2010). Saudi Arabia may play the same role as the powerful counties in the EU. To avoid the Greek crisis, which struggled to compete with other EU members (certainly a product of differing competitiveness among the Euro member states), a central fiscal authority and political union must first be built with the monetary union (Evans-Pritchard, 2010). This will provide a safety net for less competitive Gulf States.
Another problem is China. China exports cheap products. This already forced poorer Arab states to protect their industries (Evans-Pritchard, 2010). The Asian giant is operating in economies of scale being able to target areas where it can profit. For the Gulf States, a way of adjustment to national imbalances is for resources to move from areas of weak demand to areas of strong demand (Pugel and Lindert, 2002). Pugel and Lindert (2002) also explains that countries may use its high capital mobility to employ underutilized resources like unemployed labor. The GCC as earlier have high capital mobility and that much of labor in the GCC is foreign. As evidence, the Gulf has redirected foreign labor to sectors like construction and IT through the example of Dubai. This is also the Chinese way.
Conclusion
Europe has seen the success of a monetary union that was made by decades of lobbying in every nation wanting to be part of the most powerful economic bloc in history. In the Gulf, they are first in Asia and second in the world to advance towards a single currency. Borne out of the 1981 agreement on economic integration and cooperation, the GCCs goal of putting every line of national monetary and exchange rate policies into one single approach is already paying dividends. The push towards the end of that goal must go on. The GCC has prepared enough economically all the fundamental facets of integration. With its dynamic political flare and unparalleled political sincerity, the world will see a new model of economic development and politics at the crossroads where the East meets the West.