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I. Overview
Ugo Fasano
The Heads of States of the Cooperation Council for the Arab States of the Gulf (GCC) decided at the end of 2001 to deepen economic integration by establishing a common currency—pegged to the U.S. dollar—by 2010. This decision represents a practical evolution to the integration efforts that started with the establishment of the GCC in the early 1980s. As an initial step, all GCC countries officially pegged their currencies to the U.S. dollar during 2002 and early 2003 (until then, most currencies of GCC countries had been formally pegged to the SDR). Moreover, a unified regional customs tariff at a single rate of 5 percent became effective in January 2003, while macroeconomic performance criteria will be established by 2005 for the needed policy convergence to support the monetary union. The establishment of an economic and monetary union will create an important regional entity: in 2002 GCC countries had an estimated combined GDP of close to $340 billion, an average weighted per capita nominal GDP of about $12,000, and held some 45 percent and 17 percent, respectively, of the world's proven oil and natural gas reserves (Table 1.1).
| Table 1.1. GCC Countries: Selected Economic and Social Indicators, 20021 |
| | Nominal
GDP
(In millions
of U.S.
dollars) | Nominal
GDP Per
Capita
(In U.S. dollars)2 |
Popula-
tion
(In millions)2 | Overall
Fiscal
Balance
(In percent
of GDP)3 |
Total
Government
Gross Debt
(In percent
of
GDP) |
Proven
Oil
Reserves
(In years)4 | Central
Bank
Foreign
Assets
(In months
of imports)5 | External
Current
Account
Balance
(In percent
of GDP) | | |
| | |
Life
Expectancy
at Birth
(In years)6 | Illiteracy
(In percent
of popula-
tion, 15+)6 |
|
| Bahrain | 8,506 | 11,619 | 0.7 | 0.8 | 30.3 | 15 | 2.9 | 0.3 | 73 | 12 |
| Kuwait | 33,215 | 15,098 | 2.2 | 20.6 | 32.9 | 134 | 10.7 | 20.9 | 77 | 18 |
| Oman | 20,290 | 7,515 | 2.7 | 3.7 | 16.0 | 16 | 4.8 | 10.0 | 74 | 27 |
| Qatar | 17,321 | 28,362 | 0.6 | 8.3 | 53.4 | 15 | 2.8 | 13.8 | 75 | 19 |
| Saudi Arabia | 188,960 | 8,567 | 22.1 | 6.0 | 97.1 | 85 | 9.2 | 4.7 | 73 | 24 |
United Arab
Emirates | 71,187 | 19,613 | 3.6 | 9.3 | 4.5 | 124 | 4.7 | 5.5 | 75 | 24 |
| GCC countries | 339,479 | 11,9797 | 31.9 | 2.77 | 66.67 | 847 | 7.7 | 6.97 | 75 | 21 |
Sources: National authorities; IMF staff estimates; and World Bank (2001).
1Based on preliminary information available as of April 2003.
2Including expatriates.
3Including investment income of government foreign assets.
4Based on current production.
5These figures are not an accurate reflection of the country's foreign asset position because data on government foreign assets are partial in some GCC countries.
6Latest available information.
7Weighted average. |
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In the past two decades, GCC countries have made important progress toward economic and financial integration (See Section II and Appendixes I–III). Formal barriers to the free movement of national goods and workers have been eliminated, individuals and corporations of these countries have been granted national treatment for tax purposes in all GCC countries, and nationals have been recently allowed to invest in stock markets and real estate of most other member states. In addition, GCC countries enjoy low inflation, stable nominal bilateral exchange rates, and similar levels of nominal interest rates, as well as trade and payments systems relatively free of restrictions. They also share a remarkable degree of cultural and political homogeneity.
The move to a monetary union, combined with appropriate macroeconomic and structural policies, is likely to be beneficial for GCC countries. This move should, in particular, 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 addition, by requiring sustainable fiscal positions, the union should promote a better allocation of resources within the GCC area. Nevertheless, the experience of other monetary unions shows that additional convergence policies are needed to promote stronger ties in other areas and stimulate growth. Section III and Appendix IV review the experiences of these other monetary unions and draw lessons for the GCC countries.
In contrast, the costs of a monetary union—the loss of national monetary and exchange rate policies—should be limited in the foreseeable future, because important shocks are likely to affect GCC countries in a similar way, given the still high importance of oil in their finances and, to a lesser extent, in their economic structure. In addition, these countries share a flexible labor market for expatriate workers (who account for the largest share of the labor force in the non-oil sector). This flexibility has facilitated the adjustment to oil shocks, particularly under a de facto fixed exchange rate regime. Section IV discusses the potential costs and benefits of a monetary union among GCC countries.
Experience, however, suggests that a successful monetary union requires careful political and economic preparation to reduce its potential risks. Above all, a monetary union requires a strong political commitment—as member countries have to give up some sovereignty in the decision-making process—and the ability to adjust domestic economic policies to deal with the effects of a single currency. In fact, giving up national monetary and exchange rate policies could be costly if policy convergence is not sustained. Moreover, possible important changes in economic structure and trade patterns in the long run could mean that individual members of a monetary union may experience different growth and inflation effects after unification. As a result, structural policies that would promote flexibility in labor and product markets assume greater importance in a monetary union. Moreover, member countries of a monetary union need to create a level playing field among themselves to make the union successful over time, including the elimination of nontrade barriers.
GCC countries will therefore still need to make key choices and take important steps to address remaining policy and institutional differences to reap the potential net benefits of a monetary union. Importantly, the adequacy of fiscal policies and initial fiscal stance vary across countries, with the budget structure not very supportive of growth and highly vulnerable to oil price shocks across the GCC area. The incentive policies to promote economic development diverge across countries, creating cases of unfair competition. Restrictions still hinder the development of the government and corporate bond and equity markets in the GCC area. Moreover, the coverage, timeliness, and quality of national statistics, as well as the policy on transparency, differ across countries. Furthermore, the pace of structural reforms also varies across countries, with some already facing rising unemployment.
Fiscal Issues
Maintaining a strong fiscal position and adopting a common code of fiscal conduct—consisting of fiscal convergence criteria, a common accounting framework for public accounts, and adequate budgetary procedures—should receive the highest priority before introducing a common currency. This should be done in order to avoid economic strains and loss of political support, since it would be difficult to sustain a monetary union among countries with significantly divergent macroeconomic conditions and policies. Indeed, in a monetary union, coordinating fiscal policy is necessary to reduce the risk of an undesirable policy mix between member countries' decentralized fiscal policies and the union's centralized monetary stance.
The fiscal convergence criteria should reflect the need to maintain a sustainable fiscal position in all GCC countries, ensuring intergenerational economic equity objectives. However, the choice of fiscal criteria is complex in the case of these countries because of their differences in expenditure rigidity, oil dependency, as well as oil and financial wealth. Section V analyzes the options for implementing a monetary union among the GCC countries.
As a possible fiscal criterion, GCC countries could consider adopting an overall balanced budget target over the medium term based on a similar conservative crude oil price assumption across the membership, with actual surpluses or deficits only reflecting the fluctuations in terms of trade. At the same time, GCC authorities could also establish targets for closely monitoring member countries' non-oil fiscal deficits (including investment income) to determine underlying fiscal trends. A ceiling on government debt, possibly net of certain government liquid assets, could also be an additional fiscal convergence criterion to discourage countries to run ex post overall fiscal deficits for several consecutive years.
Given the volatility in oil prices and, in turn, nominal GDP, GCC countries should carefully review whether the chosen convergence criteria should be measured in percent of GDP, or alternatively, in percent of non-oil GDP, or in a common currency. A broad coverage of government activities that would include the central and local governments, extrabudgetary government funds, and pension funds should also be considered. In addition, sound budgetary practices should be followed in each member country. These practices include transparent recording of all revenues and expenditures in line with internationally accepted standards, as well as framing yearly budgets on a realistic medium-term macroeconomic framework.
Exchange Rate Policy
The GCC authorities have decided to peg the common currency to the U.S. dollar. Nevertheless, other options could be considered in light of possible changing trade patterns over the medium-to-long term—with Europe probably gaining in importance through negotiations under way for a trade arrangement between the two areas—and emerging changes in the economic structure and exports across GCC countries. These options could include pegging to a basket of currencies, or, possibly, adopting a more flexible arrangement. Other decisions about the exchange arrangement must also be made, such as the pooling of each GCC member's foreign reserves, the rate at which to irrevocably fix the bilateral rates, and the adoption of common definition—based on international standards—of foreign reserves.
Data Standards and Transparency
Assessing the success in meeting convergence criteria and adherence to policy objectives would require comparable and transparent macroeconomic and financial statistical information across GCC countries. Therefore, the harmonization of fiscal concepts and data quality based on internationally accepted standards and methods should be given high priority before monetary union takes place. For monetary policy decisions, the common central bank will also have to rely on a set of consistent, harmonized statistics, because these decisions will be based on the economic situation in the GCC area as a whole. Furthermore, such statistics are indispensable for financial market participants, as well as for making appropriate investment decisions.
Institutional Arrangements
A viable monetary union must be accompanied by the creation of a single institution (or supranational monetary authority) with clear responsibility for formulating and conducting a centralized monetary policy. Thus, the creation of a common independent central bank represents the most important institutional change that the GCC countries may face on the road toward a common currency. This change could be implemented on a step-by-step basis during the transition period to the introduction of a common currency. A decentralized approach to organizing central bank responsibilities, like that of the European Economic and Monetary Union (EMU), seems to be the most appropriate in a GCC monetary union given political and practical considerations. Under such an agreement, the common central bank will be responsible for taking monetary policy decisions, overseeing the payment systems, and coordinating efforts toward financial integration. The national GCC central banks will implement these decisions, conduct all or some of the foreign exchange operations, maintain their banking supervisory functions, and issue the common currency, as well as operate national payment systems. The contribution of each GCC member country to the capital and seigniorage distribution of a common central bank will also have to be considered.
A common central bank together with the national central banks will have to apply a common set of monetary policy instruments and put in place the necessary regulatory, legal, and institutional framework. The objective of a monetary union provides a chance to complete the process of shifting to market-based monetary policy instruments in all GCC countries and design them in a way that is conducive to the development of money and securities markets. Thus, establishing common monetary policy instruments and a securities market with some minimum depth and breadth before introducing the monetary union is likely to facilitate orderly and effective conduct of monetary policy when entering the union. A financial crisis management system will also need to be designed to avoid a conflict between any needed liquidity support provided to distressed commercial banks and the regional monetary policy stance.
Structural Reforms
Although the adoption of structural reforms is desirable independently of the
introduction of a monetary union, they are likely to enhance the positive effects
of the common currency. Thus, GCC authorities should give priority to strengthening
national labor policies by reducing domestic market segmentation between expatriate
and local workers in terms of sectors of employment, wages, and skills, while
facilitating cross-border labor mobility of GCC nationals. In addition, priority
should be given to reforms that strengthen product market competition, such
as anti-trust, commercial, and agency laws, and business codes and regulations.
A reform of the welfare and incentive systems would also be desirable to reduce
waste and improve the allocation of resources. Moreover, progress should be
made in harmonizing or coordinating taxes and pension systems, as well as addressing
rigidities in government expenditures.
The GCC countries should also take steps to facilitate the development of the bond and equity markets in the proposed monetary union. These include the harmonizing or coordination of national capital taxation, legislation (e.g., limits on foreign ownership of stocks), and accounting rules related to the holding and trading of securities and equities, as well as in putting in place integrated securities settlement systems. GCC countries should also facilitate the trend toward cross-border banking consolidation that will likely take place in a monetary union, while also focusing on enhancing corporate governance and transparency. |
