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8/8/2019 The Effects of Establishing a Monetary Union on the Integration of Financial Markets
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Preparing for CurrencyPreparing for CurrencyUnification in the GCCUnification in the GCCPreparing for CurrencyPreparing for CurrencyUnification in the GCCUnification in the GCC
Dr. Said AlDr. Said Al--ShaikhShaikhChief EconomistChief Economist
The National Commercial BankThe National Commercial Bank
April 2006
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OutlineOutline
History of Monetary Interdependence in the Gulf
Mundells Optimal Currency Area Theory
GCC and the optimality criteria Economic Benefits and cost of Currency Union to GCC
countries
GCC Preparations toward a successful Currency Union
The Future of GCC single currency
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History of Monetary InterdependenceHistory of Monetary InterdependenceIn the GulfIn the Gulf
1950s & 1960s, some Gulf States Shared a single currency (Indian Rupee)
After independence, Qatar and Dubai shared a common currency
The Riyal (1966- 1973)
In 1981, Unified Economic Agreement was approved
In 1983, a GCC Free Trade Area was established; Tariffs on goods ofnational origin were eliminated
In 2001, a decision was taken to adopt a fixed peg to the US dollar in
preparation for a monetary union by 2010
With the exception of Kuwait, other GCC states effectively pegged their
currencies to US dollar.
Kuwait dinar had been pegged to a trade weighted basket of currencies
In 2003, all GCC states officially pegged their currencies to US dollar
In 2003, GCC members implemented a Custom Union; 5% tariff on
imported foreign goods
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The Rationale to Peg to US DollarThe Rationale to Peg to US Dollar
The US dollar has been a de facto anchor in the past for all GCC
members except Kuwait, whose currency fluctuated marginally against
the dollar
Oil & gas exports are priced in US currency as fluctuations of thedollar against other currencies will be mirrored by that of GCC
currencies.
The peg to dollar also establishes a stabilizing influence for
government budgets as oil and gas are major sources of revenues.
US dollar would most likely be the anchor of the new Gulf currency
when it is established in 2010.
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GCC and the Optimality CriteriaGCC and the Optimality CriteriaDoes GCC economies meet the currency area optimality criteria
GCC states are among most open economies in Arab region;
(average Trade/GDP varies 70% to 150%)
GCC impose restrictions on ownership by GCC nationals and
Labor market regulations are not similar. GCC countries remain heavily dependent on oil; ( GCC adopt a
policy not to use ER for adjustment in case of oil shocks)
GCC have same production structure with a dominant oil
sector; this entails symmetric shocks Prices and wages dont adjust systematically to oil shocks;
government expenditures are used as a stabilizer and not ER
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GCC and the Optimality CriteriaGCC and the Optimality Criteria
Inflation rates not correlated among GCC and inflation differentials reflect
a difference in microeconomic determinants
GCC countries continue to reinforce commonalities and coordinate
economic policies; especially in the context of CU
Favorable Unfavorable
Openness *
Factor Mobility *
Degree of Diversification *
Economic Structures *Price & Wage Flexibility *
Inflation Rate Similarity *
Policy Coordination *
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Economic Benefits of Currency UnionEconomic Benefits of Currency Unionto GCC Economiesto GCC Economies
Elimination of currency transaction costs.
Elimination of exchange risk encourages intra-gulf trade & investment.
Help GCC states diversify their economic base away from hydrocarbon.
Greater transparency in pricing & improved business competitiveness.
Fiscal discipline by GCC states contribute towards low inflation &
interest rate environment within the GCC.
The new Gulf currency encourages more efficient cash management
and reduces the cost of hedging against exchange rate volatility.
For the size of GCC, monetary union would offer new trading &
investment opportunities, attracting more foreign investment. Increasing regional and international investment into GCCs capital
market
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Economic Costs of CurrencyEconomic Costs of CurrencyUnion to GCC EconomiesUnion to GCC Economies
y Loss of national sovereignty due to relinquishing of
independence control over domestic monetary, fiscal and
exchange rate policies.
y
Possible net loss in income due to lack of ability to pursueexpansionary monetary and fiscal policy during periods of
falling oil prices.
y The GCC Currency Union involves rather arbitrary
restrictions on national budgetary policies with regards to
individual taxation and spending programs.
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Preparation Toward a SuccessfulPreparation Toward a SuccessfulCurrency UnionCurrency Union
Deadline has been set for 2007
Free trade in banking and finance will require greater coordination;
monitoring and regulating
Free movement of capital will require establishing links between stock
markets; allowing for cross-listing
Allowing for free mobility of labor, including expatriate labor
1 Creating GCC Common Market
2 Creating a GCC Central Bank
Recently announced that a GCC Central Bank will be established
Exact model has yet to be decided; Merging existing ones versus onestyled on the European Central Bank (ECB)
GCC States need to agree on each states Capital Contribution
Structure and Mandate of Central Bank must be agreed upon soon enough
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3 Setting Convergence Criteria
GCC States opted for similar criteria to those of Maastricht
Acceptable levels of Public Debt ----------- 60% to GDP
Acceptable level of budget deficit ----------- 3% to GDPInflation Rate (capped at) ----------- Weighted average + 2%
Interest Rate (not to exceed) ----------- Average of lowest threecountries + 2%
Foreign Reserve (not final) ----------- 4 Months of total imports
Potential problems are likely to occur,
- especially in government deficit, usually correlate with low oil prices
- wide difference in inflation rates among GCC States
Yet, GCC need to comply by 2007 before Union achieved in 2010
Preparation Toward a SuccessfulPreparation Toward a SuccessfulCurrency UnionCurrency Union
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How GCC countries measure up to ConvergenceHow GCC countries measure up to ConvergenceCriteria based onCriteria based on 20042004 datadata
Budget surplus
of GDP %
Public Debt
of GDP %
FX reserves
Months of important cover
Bahrain *0.7 *34.3 3.8
Kuwait 19.1 21.1 8.5
Oman *4.8 *13.1 5.5
Qatar *8.6 *34.6 6.6
Saudi Arabia *10.4 *65.3 8.0
UAE 18.3 8.4 4.1
Central Government *
Source: IMF/IIF estimates, SCB Global Research calculations
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GCC Inflation Rates divergence areGCC Inflation Rates divergence areexpected to continueexpected to continue
Inflation Interest rate (%)
Bahrain 5.3 1.6
Kuwait 1.8 2.0
Oman 0.4 2.3
Qatar 6.8 1.5
Saudi Arabia 0.3 1.7
UAE 4.6 1.6
Threshold 5.2 3.6
Source: IMF/IIF estimates, SCB Global Research calculations
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Can GCC sustainably meet Budget DeficitCriteria given Medium Term Outlook for oil
Kuwait Qatar OmanSaudi
ArabiaUAE GCC
Balance 10.0 19.0 17.0 28.0 23.0 21.6
3% deficit 7.0 11.4 13.0 24.0 21.0 20.5
Source: SCB Global Research
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4 Agreement on bilateral exchange rate
In case of euro, bi-lateral exchange rates were locked in at their central
rates and were announced 7 months before its launch
The Collective peg to US dollar provides a stable bilateral rate that could
be fixed in currency union may desire to renegotiate their values againstUS dollar
5 Economic Policies Coordination
Several states interested in parallel industries; may result in some painful
adjustment
Increased cooperation will minimize damage caused by establishing
competing activities
Intra-industry activities should be developed on a regional basis whenever
possible
Preparation Toward a SuccessfulPreparation Toward a Successful
Currency UnionCurrency Union
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6 Transparency and data standardization
7 Public Awareness
The need for clear economic data will become more important to asses
convergence criteria
Reliable and timely data is important to improve investor confidence in
the region
Provide guidance to business on how to prepare for introduction of the
new currency
GCC business must be made aware of the need to ensure that their
information technology, accounting, marketing, pricing and payrollsystems have been adopted to new currency
Regulation on conversion of price will need to be published; involving
rounding to nearest unit of new currency
Preparation Toward a SuccessfulPreparation Toward a Successful
Currency UnionCurrency Union
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The Future of the Unified CurrencyThe Future of the Unified Currency
1 - Choosing an alternative peg arrangement
Trade with Eurozone and Asia account for over 60%; a trade weighted
basket of currencies maintains stability of trade revenues
Recent decline in dollar has weakened GCC currencies and has increased
the relative price of imports.
Real wealth has been lost due to holding of reserves in dollar denominated
assets
Pegging to dollar, means GCC interest rates are determined by Federal
Reserve, monetary policy is based on US economic conditions
High oil prices are generally associated with low interest rate in US, thusexacerbating pro-cyclical tendencies
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Pricing Oil in the Unified CurrencyPricing Oil in the Unified Currency
Increased exchange rate autonomy (floating the single currency) Provides GCCStates with feasibility in setting interest rates and making future economic
policy decision
2 Pricing Oil in the new currency
If GCC chose an independent exchange rate, there would be compellingincentive to price oil in the new currency
This would create demand for it as central banks in other countrieswould hold reserves in the new currency to cover their oil purchases
Increased overseas demand on the new currency would strengthen thenew currency
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