Currency union in Arab Gulf Cooperation Countries (GCC) advantages and disadvantages

Currency union in Arab Gulf Cooperation Countries (GCC): advantages and disadvantages

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Institution

Table of Contents

TOC o “1-3” h z u Economic Integration PAGEREF _Toc359500831 h 3Forms of Economic integration PAGEREF _Toc359500832 h 3Free Trade area (FTA). PAGEREF _Toc359500833 h 3Customs Union PAGEREF _Toc359500834 h 4Common market PAGEREF _Toc359500835 h 4Monetary Union PAGEREF _Toc359500836 h 5Fiscal Union PAGEREF _Toc359500837 h 6Monetary Unions PAGEREF _Toc359500838 h 7Advantages of a single currency PAGEREF _Toc359500839 h 7Disadvantages of a single currency PAGEREF _Toc359500840 h 8Criteria for forming a monetary union. PAGEREF _Toc359500841 h 8The GCC Countries PAGEREF _Toc359500842 h 103.1. Geography PAGEREF _Toc359500843 h 10Population PAGEREF _Toc359500844 h 10Government. PAGEREF _Toc359500845 h 10Economic Features PAGEREF _Toc359500846 h 11Economic growth PAGEREF _Toc359500847 h 12Inflation PAGEREF _Toc359500848 h 13Unemployment PAGEREF _Toc359500849 h 13Interest rates PAGEREF _Toc359500850 h 13International trade PAGEREF _Toc359500851 h 14Exchange rates PAGEREF _Toc359500852 h 14Central banking and monetary policy PAGEREF _Toc359500853 h 14Fiscal policy-revenues, government expenditures, surpluses/deficits, debt. PAGEREF _Toc359500854 h 15Conclusion PAGEREF _Toc359500855 h 15

Introduction

Economic Integration involves the policies found between the various states through the abolition of restrictions of tariffs in the involved countries. It is formed when two or more states agree to remove inner border tariffs, and preferences on some of the goods and import tariffs, fully or partially. The move by Europeans to integrate has made the Gulf Cooperation Council to push for the Gulf Monetary Union, which has been waited for long. The efforts to have single currency have been very slow in Gulf. In Bahrain summit, GCC leaders ratified the GCC agreement made to adopt the use of US dollar as their peg.

The GCC aims to assist the economic integration of six member countries, which are Kuwait, Bahrain, Oman, United Arab Emirates and Saudi Arabia. When a country joins a monetary union, it is in a position to accrue benefits like boosting trade, reducing risks and transaction costs. On the other hand, there is a cost to the member country as it no longer in a position to purse a monetary policy for itself. The GCC states have the same economic structures, common language, similar cultures, they are also supporting the common integration and the monetary union (Hebous, 2006).

This paper focuses on the forms of economic integration, monetary unions, the advantages and disadvantages of monetary unions and the criteria of forming the monetary unions. Besides, the paper will also look into the GCC countries’ geography, population, governments, economic features, economic growth, inflation, unemployment, interest rates, international trade, exchange rates, central banking and monetary policy, fiscal policy, the criteria for joining Gulf currency union, potential challenges and the ways to mitigate them.

Economic IntegrationThere are five stages of economic integration, which influence the global landscape. One is the free trade whereby tariffs are abolished or reduced among the member countries. This aims at improving the economies of scale, which leads to improving the economic efficiency. Second is the custom union that ensures there are common tariffs between the member countries. This means that the same tariffs are used when it comes to the third countries. Third is the common market whereby the production factors such as capital and labor can move freely to any member country. For instance, a worker is able to move from one member country to another. This broadens the comparative advantage and scale economies. Fourth is the economic union whereby fiscal and monetary policies are harmonized between the member countries. This leads to political integration. The member countries may further proceed and have a monetary union where they make use of common currency. (Levels of Economic Integration, 2013). Last but not least is the political union. This is the most improved form of economic integration, which comprise of a common government. The member country sovereignty is reduced.

Forms of Economic integrationThe forms are Free Trade area (FTA), Customs Union, Common market, Monetary Union and Fiscal Union. (Mirus and Rylska, 2001).

Free Trade area (FTA).

This is formed when two or more states agree to remove inner border tariffs, preferences on some of the goods and import tariffs. There are rules to remove the zero tariff exploitation in the free trade area. For instance, a certificate is required to show the origin of the goods that come from a member of the territory of the free trade area. There is a minimum requirement for the goods that are traded in the area, and once the goods meet the required standard, they are accorded a special treatment by the provisions of the FTA. The members have different customs and quotas (Mirus and Rylsaska, 2001).

In the industrialized countries, there are very few barriers in the exchange of commodities and services. In some cases, there are no obstacles at all, no import quotas, no tariffs in trade, and no delays when the goods are being transported from one country to another. The differences in regulation and taxation are eliminated. For a free trade agreement to be legible, the importers must be in a position to access information of the product from the suppliers in the supply chain. The importer should then be in a position to evaluate the eligibility of the delivered products in consideration to the rules of origin. There is also an automated machine to assist in this.

Customs UnionThis is one of the trade blocs. It consists of a free trade area that has an external tariff, which is common. Countries that take part in this union agree to put in place a common external trade policy. However, in some of the cases they make use of various import quotas. Competition policies common to all the countries also help to reduce deficiency of competition.

The customs union establishes very close cultural and political ties among the member countries, and also increases the economic efficiency. The customs union is as a result of trade pacts. Some examples of the customs Union are EU-Andorra, Eu-Turkey and the East African Community. Some of the proposed customs unions are the COMESA, SADC, and ECOWAS among others (Wikipedia, 2013).

Common marketThis is a pre requisite of the single market. In most of the cases, it is limited to FTA and is in respect to free movement of goods and services. However, a common market is not very advanced in consideration to the reduction of other trade barriers. The single market is comprised of FTA of goods and common policies in the regulation of products. There is also the labor and capital, also called factors of production, as well as the freedom to move from one state to another. The main aim is to ensure there is free movement of goods, services, labor and capital between the members. All the technical, fiscal and physical barriers are eliminated for the member states(Mirus and Rylska, 2001).

A common market has many benefits to the member states. There is unlimited freedom in relation to movement because the factors of production are well allocated to increase the productivity. Competition is also enhanced hence no monopoly, and therefore the inefficient companies suffer a great deal. Efficient companies have an advantage of low costs and increased competitiveness. The consumers benefit in the sense that as the competition increases, the companies become more creative and innovative hence bring in new products into the market. Some of the main examples of Common markets are AIT, EFTA, SAFTA, EEA, and Switzerland European Union (Mirus and Rylska, 2001).

Monetary UnionThe monetary union involves a situation whereby states unite and agree to use a common currency. However, this can be done without the states having any other integration such as economic or even monetary union, which involves single market and customs union (Wikipedia, 2013). The three types of the currency unions: formal, informal and formal that has common policy.

Formal: this is where the states adopt a foreign currency through the virtue of multilateral or bilateral agreement through issuing authority. In most cases, local currency issue in the regime of currency peg supplements it.

Informal: it entails the unilateral adoption of the foreign currency.

Formal that has common policy: this type is made up of several countries, which have a monetary policy that is common. These countries have an issuing authority in matters to do with the currency.

An example of a currency union is the CFA Franc which is used by countries such as Burkina Faso, Benin, Guinea Bissau, Niger, and Mali; Cote d Ivore, Togo, Senegal, Chad, Congo, Cameroon, Gabon AND Central African Republic.

Fiscal UnionThis involves the combination of state’s fiscal policy. The decisions on expenditure and collection of taxes are the responsibility of common institutions as well as the governments that participate. In the United States for instance, the body that determines the fiscal policy is the central government. It has the mandate to spend, borrow and raise taxes (Economic online, 2013).

Another example is the European Union, which makes use of the fiscal union. The members are participants of EMU (economic and monetary union). They use the euro currency. The decisions on taxes and the way to spend the tax are managed at the national level. This means that even if the EU has monetary union, they do not possess fiscal union. Control of the fiscal policy is in the national level and in the entire world; no substantial union has been made between any independent nations. Some of the fiscal powers that the European Union enjoys are that; it decides on the consumption tax levels and tariffs imposed on the external trade, and they spend a lot of billions of Euros, which enhances the stability and growth pact. This is between the members of the common currency zone, which is meant to co-ordinate all the fiscal policies for the states (Wikipedia, 2013).

Monetary UnionsAdvantages of a single currencySome of the advantages of single currency in a group of states include:

The bargaining power. The members are in a position to acquire intrinsic incentive that makes them have a broader scope to bargain. This enables the member states to negotiate with different trading blocks.

Increased intra trade. It is easier for countries with the same currency to trade. This leads to synchronized business cycles, which increase the benefits accrued as a result of common currency.

Easy comparison and economies of scale. The producers are in a position to have the economies of scale, especially when there are no barriers in the border and the currency is the same. Besides, their market is enlarged. The consumers also have an advantage as there is a lot of competition among the producers: they access the best products at low prices.

Eliminating the risk of foreign exchange. Single currency reduces the risks that are common in the exchange rates of currency. On the other hand, a common currency promotes the integration and development of the markets such as the stock market and bond market.

Increased potential investments. Monetary unions make the economic prospects promising as they reduce the administrative procedures and search costs to provide a large market. This is for both the foreign and domestic investors.

There is financial market integration in the states with common monetary union. This is as a result of the financial discipline, as well as the transparency among the countries. The union attracts investment which emanates from the region, national or even international levels (Alkholifey and Alreshan, 2010).

Promotes an economic policy that is more disciplined. A strong exchange rate enables the member countries to adopt better monetary policy measures.

Disadvantages of a single currencyHigh Cost: it is expensive to craft and adopt a common currency. The market flexibility is also affected.

The central bank of a country under the monetary union is not authorized to alter the interest rates or exchange rates. This is the responsibility of the central bank for developed by the union. This also increases the cost (Alkholifey and Alreshan, 2010).

Criteria for forming a monetary union.There is no set or agreed criteria in the formation of a monetary union. There is however, one that is widely discussed especially in regard to the GCC countries. In line with the criteria for joining a Gulf currency union, this common criterion is as discussed below.

Synchronization of business cycle: The countries that have business cycles that are highly correlated are in a position to join the monetary union their response to shocks is symmetric. If for instance the member countries are hit by shock asymmetrically, the policy responses will be different in all the countries. If all of these countries are monetary union members, then the monetary policy, which is common, will not be in a position to stabilize all the members together (Alkholifey and Alreshan, 2010).

The intra region trade: As noted earlier, a common currency lowers the transaction costs. For instance, in the GCC countries, an increase in bilateral trade among the members increases the cost savings. These countries have trade policies, which are liberal among other countries in the world, and this dominates the intra regional trade. Countries that produce very competitive products should therefore be in a position to search for market outside the union to increase their sales (Alkholifey and Alreshan, 2010).

Stable exchange rates. The countries with a common objective to have a monetary union must agree on the exchange rate that is stable. For example, the GCC countries use the US dollar in their foreign trade of oil (Alkholifey and Alreshan, 2010). A common currency is in a position to improve trade especially when there are significant risks in exchange rates.

Capital and Labor Movement: People who live in the monetary union countries should have freedom to move from one country to another, and even work without discrimination in any of those countries. There should also be free labor and capital movement. Increase in the adoption of technology makes it easy for the capital movement between the countries.

Political will: The political commitment and determination is very vital in the success of a monetary union. The will makes it possible for the member countries to overcome all the challenges and obstacles encountered in the formation of monetary union. If the political commitment is shaky, the speed as well as depth of integration reduces. In the case of Gulf monetary union, there was a very strong from the political leaders. This was evident as the GCC leaders had taken a multilateral initiative in Manamah summit held in December 2000. They also adopted US dollar to be used as the single currency and, created an economic and financial committee, which was mandated to look into the requirements for GMU. They later approved the monetary council law, as well as the monetary union(Alkholifey and Alreshan, 2010).

The GCC CountriesGulf Cooperation Council was established in 1981 as result of Islamic revolution, in a country called Iran (Takaji, 2012). The main objectives for the GCC countries are integration, coordination and integration in all areas among the member states, commerce, communication and customs and formation of regulations in financial and economic affairs that are the same. For this to be achieved, the member countries had to come up with three entities, which are supreme council, ministerial council and secretariat general. These acted as the government.

GeographyThe entire area of the GCC countries is equivalent to about six hundred and thirty million acres, which is equivalent to two thousand four hundred and twenty three square kilometers of land. They range from the Persian Gulf in the United Arab Emirates, Saudi Arabia, Bahrain, Oman, Kuwait and Qatar (Takaji, 2012).

PopulationThe population of the GCC members is about 45.9 million people. Bahrain has 0.8 million, Kuwait has 3.1 million, Oman 2.1 million Qatar has 1.5 million, Saudi Arabia has 26.3 million and UAE has about 4.7 million people (Wikipedia. 2013).

Government.The GCC has a charter that shows the framework of governance and also the bodies involved in the decision making. The supreme council is the highest body of decision-making. It comprises of member state heads (Takaji, 2012). The members meet at least once in a year. Resolutions made require a majority vote. From the supreme council is the Commission involved in settling disputes. This is formed to ensure there is peace among the state members. There is also a ministerial council, which comprises of the foreign ministers and also delegated ministers. This council meets after every three months. They are supposed to propose policies, manage the decisions of supreme council and also prepare recommendations. They also act as the coordinators of the cooperative initiatives. Every member has one vote and the resolutions made require a majority vote. From the council is the secretariat general, which comprises of the secretary general, assistant and the staff. This body prepares agendas and accesses the policies implementation. The Secretary General and the assistant are required to perform their duties with a lot of independence for the interest of the members of state (Takaji, 2012).

Economic FeaturesThe table below summarizes the economic features of GCC countries

Bahrain Kuwait Oman Qatar Saudi Arabia UAE GCC TOTAL

Population in millions (mid 2010) 0.8 3.1 2.9 1.5 26.3 4.7 39.2

Nominal GDP in billions (US dollars) 22.7 132.6 57.9 127.3 448.4 302.0 1090.9

Per capital GDP In us dollars (2010) 28025 43475 19897 84305 17082 64119 27801

Expatriate workers in total workforce in %(2006) 59 81 33 89 47 90 56

Rate of unemployment among the countries(estimates in % for year 2009-11) 4 3 12-13 2.4 10.5 3 –

Source: Takaji (2012)

From the table, Saudi Arabia has the highest population followed by UAE. The difference is 20 million people. The smallest population is Bahrain with a population of one million. Consequently, the GDP follows the same trend as Saudi Arabia leads. The country produces almost a half of the GCC total output of one trillion since 2007. This means that the country has dominated the regional power, and plays a big role in the development of regional cooperation. When it comes to per capita, in the year 2010, Saudi Arabia had 17,100 US dollars, which is why it is said to be the poorest as compared to other regions. Qatar in this case leads with over 84,000 US dollars and UAE follows with 64,000 US dollars(Takaji, 2012). .

The expatriates, both menial workers and professionals are employed in private sector. The nationals are absorbed by the public sector. This leads to job mismatch and reduces the employment opportunities for the nationals in private sector. The rate of unemployment is not very high though it is high in Saudi Arabia and Oman especially for the young people. It is said that more than 25% of the young people in the age between 25 and 29 years, are unemployed. This poses a great challenge to the GCC to offer this growing population jobs.

Economic growthThe GCC countries are oil based and have the largest oil reserves in the world. The region produces and exports petroleum products. Since 2001 to 2008, the countries had a good economic improvement: it multiplied to about 1.1 trillion. This was as a result of the demand for oil up to the year 2008, a good geo-political environment, an increase in the reform measures and a boost in the private activities. The gas and oil sectors showed about 73% of export earnings (Hebous, 2006). The region continues to exercise programs of economic reforms, which attract domestic, regional and foreign investors in the oil and gas, real estates, as well as in the telecommunications. The decline in oil global market as a result of economic crises and global financial crises reduced the pace of development projects and investment. For example, GDP reduced by 19.3%. The economy improved by 6.4% in the year 2008 as compared to 5.1 % in the year 2007. This reduced drastically in 2009 to 0.5% (Takaji 2012). This is expected to improve with a rate of about 4.5% per year. However, the economic recovery across the globe, aims at a sharp rebound in the economic activities in the region.

InflationFor a long time, the region has shown a record of minimal inflation rates. In 2001 to 2004, the inflation rate was between 0.2% and 2.1%. This was as a result of prudent management in the monetary policies and fiscal policies, as well as in the availability of products and services. However, there was a high inflation rate in 2008 of 10.7%, as compared to 2007 when the rate was 6.7%. This was because of imported inflation, the US dollar depreciation, a reduction of interest rates, high spending, ample liquidity, and a housing shortage imbalance of demand and supply for goods and services among others. The inflation is however expected to improve in every year (Habous, 2006).

UnemploymentThe rate of unemployment is not very low. However, as was noted earlier, in Saudi Arabia and Oman, especially for the young people, more than 25% of the youths aged between 25 and 29 years are unemployed (Takaji, 2012).

Interest ratesFor the past two decades, there was an increase of interest rates. Qatar demonstrated a fixed interest rate up to the year 1990. Later on, the rate fluctuated as it did in the other GCC countries. Saudi Arabia and Bahrain interest rates coincide with that of United States. The difference in the interest rate between the highest country and the lowest country is negligible.

International tradeThe GCC countries have been able to achieve a high level of trade and financial integration in the entire world economy. They had invested heavily before the beginning of global crises. They benefited a lot from the oil income, which led to high prices on energy and increased the world demand.

Exchange ratesUntil the year 2001, the four currencies, namely, Qatar riyal, Bahraini dinar, UAE dihham and Saudi Arabian Riyal, fluctuated around special drawing rights value. The other two currencies are Omani rial, which is pegged to US dollar, while Kuwaiti dinar becomes determined in respect with weighted currency basket. However, all the currencies except Kuwaiti dinar have been having a fixed exchange rate for the past two decades (Hebous, 2006).

Central banking and monetary policyMonetary policy maintains the financial stability domestically, as well as preserves the exchange system rate to which it is pegged. Besides, monetary policy coordination requires collecting, evaluation and processing of information necessary for conducting monetary policy. Member countries should also be willing to work together with the aim of having a consensus. In Gulf, the monetary policy is thought to be less effective as compared to the economies, which have ER arrangements. They float together and do not have better developed secondary capital market. The gas and oil in Gulf are still the main exports and act as the main source of foreign exchange. In this regard, people expect that the central bank that was created, and the national banks in existence, have similar price stability or monetary policy objectives. However, now that the exchange rates are the responsibility of Gulf central bank, there are situations that are in conflict with the external stability and domestic price on the exchange rates (Alkholifey and Alreshan, 20120). For effective stabilization to be seen, the need for a centralized monetary policy control arises. This is the reason as to why a central bank that is union wide was created.

Fiscal policy-revenues, government expenditures, surpluses/deficits, debt.Fiscal policy involves revenue collection and government spending. For instance, when there is low demand in economy, it is possible for government to get involved and increase spending so as to increase the demand (Diffen, 2008).

The government expenditure is one that is influential in the economic activities of the GCC economies. The current expenditures such as wage bill for the government, which represents the budgets of GCC members, was close to 71% total expenditure in the year 2007.

GCC continue to rely on the revenue obtained from oil, which is about 70% of the total. Without centralizing fiscal activities, or harmonizing the budgets nationwide, fiscal deficit from one country could lead to deficit on balance of payments for the whole union.

Potential challenges, and possible ways of mitigating the challenges

The main challenges that face the GCC members is diversifying the economy as well as maintaining a non oil sector that is strong. There are actions being undertaken to support direct foreign investment, privatization, tourism sector, development of infrastructure, coming up with financial sectors among others. This is happening especially in two countries Bahrain and UAE where there is little oil dependency. There is a project to improve the tourism sector and make it the leading business in the area (Hebous, 2006). Diversification as well as enhancing the activities of non oil poses a great challenge. This is the creation of jobs and reforms on labor markets. The region has a high population. However, the public sector is not in a position to increase the labor supply. As a result, of this, diversification is an urgent need.

ConclusionEconomic integration is one that allows exchange of goods and services to proceed in the whole world. The countries involved agree to get rid of import quotas and tariffs, come up with common external quotas and tariffs, allow a common market in that there is no restrictions for workers, goods and services among the member countries, establishing political and economical unions and they harmonize structural, monetary, fiscal, competition as well as social policies.

GCC countries are an oil dependent area and they operate on an exchange rate that is fixed that in the US dollar. The monetary union formation reduced the costs. A fixed exchange rate exists, and therefore the introduction of common currency is not a very big deal. On the other hand, GCC states have achieved convergence criteria just like in Europe. This means that the combination of GCC states does not reflect a big volume of economic benefits. This therefore reduces the dependency of oil to maintain a better and stronger economy.

References

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