IS THE GCC AN OPTIMAL CURRENCY AREA? By Adnan Ahmed Qatinah Mohammed Ghiath HASAN AGHA Husam Al Dakak Alaa MohamedECONOMIC CHANGE IN THE ARAB REGION
• Introduction• The theory of Optimum Currency Area • Definition of Optimum Currency Area • Potential Benefits and cost of Optimum Currency Area • Criteria of an Optimal Currency Area (OCA)• GCC Countries and the Optimality Criteria for OCA • Overview of the economic cooperation in GCC • Overview of GCC economics • Benefits and Costs for GCC to have OCA • Does GCC meet the criteria of an Optimum Currency Area?• Conclusion
In 2001, the Gulf Cooperation Council countries (GCC)(Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United ArabEmirates) decided to introduce a common currency by 2010.Furthermore, in 2005, the GCC members adopted theEuropean Union (EU) convergence criteria with respect tobudget deficit, public debt, currency reserves, interest rate, andinflation. The main objective of our presentation is toinvestigate to what extent the GCC member states meet thetheoretical criteria for an optimal monetary union.
Mundell stated “economic efficiency would bemaximized in a geographical region if the region allshared a single currency". Professor Robert Mundell, 1999 Nobel Laureate: the father of the Theory of Optimum Currency
1981 • The Gulf Cooperation Council (GCC) was established.1983 • Free Trade zone was established to enhance economic integration.1999 • Customs Union was established.2003 • GCC countries pegged their currencies to the US dollar as well as established a common external tariff of 5%2008 • GCC countries agreed to introduce a monetary union.
Average Growth Rates of Nominal GDP Saudi GCCPeriod Bahrain Kuwait Oman Qatar UAE Arabia Average1970s 25.1 30.6 46.4 31.3 47.7 51.1 38.71980s 3.0 -3.3 7.1 0.1 -2.5 2.1 1.11990s 6.6 11.3 5.9 10.3 5.2 8.0 7.92001-2007 13.9 17.3 10.9 20.8 10.8 15.7 14.9
BENEFITS• Reduces transaction costs• Bargaining Power• More Intra Trade• Economies to Scale• Removal of Foreign Exchange Risk• Fixed Exchange RatesCOSTS• Unitary Monetary Policy• Constraint on national fiscal policy;
• Openness• Diverse Production• Mobile Labor• Transfer Criterion• Homogeneity of preferences• Solidarity vs. nationalism
• McKinnon suggests that countries with a small open economy, which trades intensively with the world, would be good for them to join an optimum currency area. Ronald McKinnon Source: http://www.stanford.edu/~mck innon/
Openness degree of the GCCThe GCC economies have traditionallybeen open to international trade ingoods and services. Asia and theEuropean Union have accounted forabout two-thirds of GCC exports and Bahrain Kuwait Omanimports. Qatar Saudi Arabia UAE
GCC trade in 2010Intra-GCC trade has been low (less than 10percent) due to the fact that all the GCCcountries are mainly oil producers and havesimilar economic structures. Intra-trade Extra-trade
Small open economies GDP Trade Openness Intra-GCC Country Bn USD Bn USD % of GDP % of tradeBahrain 15 21 133% 16.3%Kuwait 94 74 78% 4.8%Oman 35 32 91% 17.2%Qatar 52 44 85% 7.4%Saudi Arabia 346 250 72% 4.3%UAE 158 247 157% 5.1%GCC 701 668 95% 6.1%World 48,121 24,365 51%Source: Global Insight, IMF DOTS, Ecowin,
As far as the Mckinnon criterion isconcerned, most of GCC economiesqualify for joining a monetary union.They are very open, they may will notface asymmetric shocks.
Kenen stated that countries with a wide range ofproducts and similar production structure are morelikely to form an optimum currency area with lowerprobability of asymmetric shocks.Asymmetric shocks are more likely to have greaternegative impact on countries with less diverseproduction. Peter Kenen Source: www.princeton.edu
Despite the efforts to diversify theireconomies, GCC countries remain heavilydependent on oil. Since 1991 oil and gasincome constituted, in average, 35 percentof the GDP, 77 percent of total exports and74 percent of government revenues.
GDP shares by sector Oil and Financial Other Country Manufacturing Government Construction Other Gas services servicesBahrain 26.48% 12.33% 14.87% 19.80% 4.78% 12.99% 8.75%Kuwait 54.49% 7.45% 11.99% 10.36% 1.93% 4.90% 8.88%Qatar 59.57% 8.44% 8.87% 6.34% 5.66% 4.44% 6.68%Saudi Arabia 50.13% 9.48% 16.09% 6.68% 4.52% 5.19% 7.91%UAE 36.05% 12.95 9.18% 13.59% 7.99% 10.88% 9.36%GCC 45.34% 10.13% 12.20% 11.35% 4.98% 7.68% 8.32%Source: UNSD- Key Global Indicators, 2009
As far as the Kenen criterion isconcerned, most GCC economiesare qualify for joining a monetaryunion, because, their economiesare similar production structure andasymmetric shocks are not morelikely among GCC.
• Labor mobility is the key to dealing with asymmetric shocks in a currency area. Thus, workers promptly move in response to economic incentives.• full labor mobility occurs if people immediately take advantage of any different in earnings, and move where they can earn more. Economic Factors Non-Economic Factors The cost of moving Culture differences The prospect of becoming unemployed Family and friendship links Career opportunities Current, Future Commitment to one’s country of Origin Family career prospects (spouse, children) Social benefits (subsidizes) Taxation of earning both labor and saving
• Articles within the GCC Charter, in both the original Unified Economic Agreement of 1981 as well as the new Economic Agreement of 2001 contain specific provisions allowing full and complete freedom of movement for citizenry.• The GCC documents demonstrate a fairly liberal interpretation of free movement rights, allowing citizens to move across the six states’ borders for a variety of purposes, including residence and employment, and to gain access to a host of social security benefits in any of the member-states
GCC National Working in Qatar (2010) Nationality Total Kuwait 77 Bahrain 633 Oman 4,051 Saudi Arabia 775 United Arab Emirates 263 Total 5,799Source: Data Collected from Qatar Statistics Authority
Foreigners as percent to total population in GCC countries in 2007 •Estimates put the number of foreign workers in the Gulf at about 13.9 million in 2007. • We can conclude that, labor mobility situation might be unable to play a major role to deal with asymmetric shocks in a GCC currency area. N/ABahrain Kuwait Oman Qatar Saudi Arabia UAE
• OCA countries have to give up the exchange rate instrument used to response to adverse shocks that hit an economy of this area. The rest better off economies transfers compensation. When adversely hit, a region sees its economy decline, so the tax payments by its residents decline and the various welfare payments (unemployment, social subsidies) rise.• Given the recent economic boom, GCC has obtain a huge reservation and sovereignty funds, these effective instrument will enable GCC countries to face any adverse hit.• On this Criterion, GCC is definitely an optimum monetary union.
Budget Surplus/ deficit for the GCC Countries % to GDP Country 2003 2004 2005 2006 2007Bahrain 1.8 1.4 5.1 2.3 0.6Kuwait 10.0 15.1 29.1 17.6 29.7Oman 1.4 2.4 2.5 0.3 0.3Qatar 3.9 16.4 9.2 9.0 14.7Saudi Arabia 45 11.4 18.4 21.7 14.6UAE -4.5 -0.4 8.1 12.0 9.5Source: Secretariat General of GCC, and Oman Central bank annual report
• In case of asymmetric shocks, country members of a currency area should have a common reaction policy.• Establishment of common monetary institutions is a key element. (EUCB).• The monetary and exchange rates policies have been cooperated in the GCC in response to exogenous shocks. (Kuwait is an exception).• This criteria is likely to be met by GCC countries.
Criterion Satisfied?Openness YesProduct Diversification YesLabor Mobility NoFiscal Transfers YesHomogeneity of Preferences YesSolidarity vs. Nationalism No
• For a currency area, sense of solidarity to the union needs to overweight the own national interests.• In case of its establishment, the GCC central bank might suffer from lack of political support.• This might be a crucial factor resulting in catastrophic outcomes for the GCC in case of forming a currency area.