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Gulf Currency Union Research Paper


Abstract

Formal and informal criteria are adopted to assess the readiness of Gulf Cooperation Council (GCC) for a currency union; some suggest that the countries have attained the minimum requirements while others don’t. By using (OCA) criteria, it is evident that GCC countries are yet to meet all the conditions required for the establishment of a currency union.

The economic structures of the GCC economies have minimal diversification and depend largely on the oil sector; non oil sectors are seen as lagging behind with minimal investments in the sector, much of non oil products are imported.

Despite efforts to diversify the economies income from oil forms more than 75% of the countries’ export earnings. In spite of the fact that, the GCC countries have managed to engage in intra-regional trade, they have achieved very little in this respect as there is no convergence in their macroeconomic policies despite synchronizing their business cycles.

Despite the situation at GCC there are some OCA criterion conditions that the countries have been able to meet effectively, for instance labor and capital can move easily from one country to the other implying that there is factor mobility. Moreover, these countries have open economies that make the use of a common policy easy. In general, GCC countries have only managed to fulfill very few of the required conditions; this shows that there is much to be done.

Inflation rates are not similar in all countries and wages and prices are not flexible enough to correct a market uncertainty; Saudi Arabia as a GCC country is likely to benefit from goodies from the union and in the case of costs, the country still stands to duffer. Saudi Arabia is one of the countries in the GCC that has highly met the demands of a union formation, however it cannot stand on its own as a union; it has to look for support and economic welfare of other countries to become a union.

However, when gauging the readiness and preparedness of the countries using purchasing power parity (PPP), GCC countries shows a high preparedness for a currency union, the parity comparison is further reinforced by similarity in economic movement parameters. Majority of GCC countries are committed to a fixed exchange rate regime by pegging their currencies to the dollar and they are politically stable. This shows that if GCC countries follow the steps of Saudi Arabia, they can get on the right path toward currency union.

Although there is limited diversification and intra-regional trade, once currency union is established, trade will be expanded and this will pave way for diversification and the GCC countries will be able to achieve full integration as a block and Saudi Arabia will benefit from economic, political and social integration benefits. The major cost associated with the establishment of a currency union is that the countries will be forced to surrender their monetary policy, meaning that they can only use the common policy for adjustment.

In order for the GCC countries to enjoy the benefits of currency union, there is need to speed up economic integration and meet the necessities of the GCC common market.

This can only be possible if each of the GCC countries is willing to give up some of their state-run privileges for the benefit of the entire region. In this research, focus will be made on the benefits and costs that GCC countries can get after they have formed a fully operational currency union, however as a case study country, the focus will be on the benefits and costs that will accrue to Saudi Arabia.

Introduction

In May 25, 1981, the countries of the Arab Gulf region, established a cooperation known as the Gulf Cooperation Council (GCC) to pioneer efforts of economic integrations among the countries; in the meeting Saudi Arabia was one of the player who seemed prepared for the upcoming economic benefits as well as ready to meet associated costs.

In the efforts of formalizing the intended economic integration, the council held a supreme meeting in November 1981, to discuss on issues to facilitate the attainment of the integration goals; in the supreme meeting, the issues discussed touched on foundational matters to be considered like integration and cooperation logistics.

GCC was given the responsibility of creating a path that would help the Arab state realize economic integration, some of these tasks included forming a free trade area, a custom union as well as an economic union. The council was able to achieve these objectives through the help of specialized committees established for the sole purpose of implementing the guidelines of GCC.

In 1983, a Free Trade Zone was recognized marking the first step in the direction toward economic integration for the Arab states. The next step was to establish a custom union which took a relatively longer period of time until the year 1999 when the Riyadh Summit was organized for the GCC leaders. At this summit, the leaders agreed to form a timetable that would hasten the process.

Full economic integration would not be achieved with different currencies being used in the Arab states and the GCC leaders had to look into that. It was in a summit held in Bahrain in 2005 when the leaders agreed to adopt a common peg to represent the different currencies of the Arab states. This was seen as the first step in the direction of adopting a single currency for the member states that would ensure full economic integration (Louis & Osman, 2008).

By 2001, the heat of the integration was catching up and leads to a GCC leader’s summit meeting at in Muscat where the six member state agreed to have a common customs tariff of five percent by the end of two years.

They went ahead with the discussion of a common currency and agreed that by 2010 the Arab states would have a single currency. As a preliminary step towards the establishment of a single currency, the GCC leaders decided to peg their currency to the American dollar by the end of 2002 (Berenguat & Elborgh-Woytek, 2006).

This was all in the yearning of economic integration as well as a common currency that would make transactions easy. The Arab states belief that, for a complete integration, all transactions costs should be eliminated among other uncertainties that come about because of the use of different currencies. To them, a common currency is the only key toward full integration. With it, individuals can transact easily across borders and their mobility would be improved.

However, the road towards a common currency is not without obstacles as certain requirements have to be met. First, the worth of creating a common currency had to be tested in regard to a number of standards recognized by the theory of Optimum Currency Areas (OCA).

OCA requires a verification of the optimality of forming a Currency Union (El Kuwaiz, 1988). Countries that have expressed their desire to form a currency union have to go through a deep assessment aimed at establishing the worthiness of creating a common currency. It is not always the case that countries are granted their wish because there are instances when OCA refuses to allow countries to form a common currency if it deems it invaluable.

It is from this perspective that this research paper seeks to establish the preparedness of the Arab states for the formation of a common currency. The first part of this paper gives an in-depth analysis of the Gulf Cooperation Council; when it was formed, its composition, and its main responsibilities.

The second part gives the definition of a currency union and highlights some of the benefits and costs that a region stands to gain once a currency union has been established. The third part of the paper gives some of the expected benefit of Gulf Currency Union once it is established. These are the benefits and costs accrued to GCC members after establishing a common currency. The Optimum Currency Criteria is looked at in the fourth part and the fifth part gives an assessment of the GCC in relation to the OCA criteria.

With current globalize worlds, countries are looking at ways through which they can join efforts and economic powers to compete effectively with other nations; economic globalization refers to the increase in national interdependence of economies through an increment in international trade, this is the route that GCC countries have decided to adopt.

This is the process of promoting economic integration between economies of different countries with the aim of establishing a global market, however there are a number of logistics that needs to be accomplished in that effect. Through economic integration, nations get a wider access to the world economy and their dependence on local resources is reduced. For trade to be complete there must be the demand and supply of commodity.

When good are supplied in one particular country, they are subjected to various supplies logistic before they reach their destination. Some of the logistic may be trade barriers, protection measures taken by importing country or natural barrier like language. GCC countries had the mind of solving their economic, social, and political differences for the benefit of their nations, they focus on large and diversified nations as well as nations that are struggling to meet their demands.

Problem definition

Globalization and regional integrations aims at benefiting the participating nations; however the case is not always true that the countries benefit. Some costs are incurred, the costs may be monetary, social, political, and those that relate to decision making.

Before Saudi Arabia commits to incur these costs, it is important to undertake a review that takes the form of cost-benefit analysis; the parameters will be tested in the form of economical, political, and social angles. With the required analysis in mind, this research aims at collecting information (economical, political and social) and determines whether the Saudi Arabia is set for a trade union and if set whether it should invest drive the goal of investment.

Motivation of the research

The main motivator of the research is the economic situation prevailing in modern globalizing world; there is a move to regional integration that continues to create trading blocks among regions. Despite the benefits from regionalization, some countries have continued o suffer from the integration; for example the EAC was enacted with the role of facilitating trade in Kenya, Uganda, Rwanda, Burundi, and Tanzania; however there have been challenges meeting the demands of the community.

Again some countries like Tanzania are complaining that the deal is likely to injure their economies. With the rivalry in the community, the researcher has noted the need to interpolate the effect that a custom union would have on Saudi Arabia.

In unions that seem more stable like the EU have had their issues, they have been having complains among members and making decisions have become a challenge; for instance in 2011 there have been debates whether Turkey should be admitted as a member, this created friction among the member.

In the same year, some countries like Britain have been contemplating whether they should leave the union. With these reality and differences in opinion, the researcher has found it’s important to research on the effect that joining custom union would have on Saudi Arabia.

Literature review

The gulf cooperation council history

In early years, between 1975 and 1978, there were efforts that had been adopted by Kuwait, Bahrain, UAE, and Qatar to establish a monetary union that was to facilitate trade among them, it was the initial step toward the Gulf currency (El Kuwaiz, 1998); however, their attempt was rendered futile and the process toward Gulf currency was brought to a standstill.

In May 1981 GCC charter was signed to facilitate the integration of the nations, the signing also attracted two other countries Saudi Arabia and Oman; with the six, census estimates that was conducted in 2007 shown that the combined population of the six countries was approximately 37 million and their gross domestic product was about 821 billion US dollar (Louis & Osman, 2008),

Upon the establishment of the GCC, the six members had common objectives, this included integration, formation of similar regulations, coordination, among others; this called for an erection of overseeing body of three entities. These entities are: the Supreme Council, the Ministerial Council, and the Secretariat General.

The GCC countries share many similar aspects. For instance, they share a common language, history, and culture; have common economic and social challenges and their economies seemed to be focused in one line. The Gulf countries are among the leading countries in the world in the production of oil. Statistics show that almost 40% of the entire oil reserve in the world is found in GCC countries. From these reserves, the GCC countries are able to supply more than 20% of crude oil in the world.

It is estimated that about 24% of the world gas reserve is found in the GCC countries; with the huge reserves the countries only produce 7.9% of the world’s natural gas; these countries are able to extract gas and oil more easily than other countries and this gives them a competitive advantage over other oil and gas producing countries. Through oil and gas exports, the Gulf countries accumulate wealth, which boasts their economies thereby improving the standards of living as well as the infrastructure (Louis & Osman, 2008).

2007 statistics show that total GDP for the GCC countries rose from 11 billion US dollar in 1971 to 821 billion US dollar in 2007. However, this high GDP is being used to cater for the needs of its population which is estimated to have increased from 8.5 million in 1971 to 37 million in 2007 (Louis & Osman, 2008). The average growth in GDP can be broken down in table 1 at the Appendixes 1.

In particular, the Saudi Arabia has had an improving economic growth rate that varies with the world’s economic performance: the following graph interpolates some economic parameters of Saudi Arabia:

Graph 1

Saudi Arabia’s GDP Graph.

In 2007, the country was badly affected by global financial crisis but the rate of recovery of the country is high and showing better results; the graph below shows the current rates of GDP growth rate of the country:

Graph 2

Saudi Arabia’s GDP Growth Rate Graph.

Inflation is another factor that has continued to hinder a fast economic development of Saudi Arabia; the following graph shows the changes in inflation in the housing sector:

Graph 3

Rising Saudi Arabia’s Inflation.

Recently, the GCC countries have been under a lot of pressure to diversify their manufacturing sector in order to reduce their dependence on oil. Factors that have been contributing this are; the fact that oil is a non-renewable resource that can be depleted and the world is trying to look for alternative energy sources and the GCC countries fear that this might compete with oil.

The other factor is that the rate of growth contributed by the oil sector may reduce as time goes by due to demographic changes and the global increase in the supply of oil from other regions. These factors coupled with other economic setbacks increases the need for economic diversification of the GCC countries so as to meet the global demand.

Currency union/monetary union and the effect it can have on Saudi Arabia

The European Monetary Union (EMU) can be used to shed some light on the definition of a monetary union. The 1970 Werner Report on economic and monetary union in the European community states “A monetary union implies inside its boundaries the total and irreversible convertibility of currencies, the elimination of margins of fluctuation in exchange rates, the irrevocable fixing of parity rates and the complete liberation of movements of capital” (The Werner Report of 1970).

The nature and the structure of the union had the exchange rate as fixed and common across the countries of the union. In this line, a currency union can be defined as a region that accepts a single currency as its medium of exchange.

A currency union is characterized by three major aspects; single currency, union-wide monetary policy, and a single external exchange rate policy (Masson & Pattillo, 2001). A currency union is associated with a number of benefits to the member countries. The section below summarizes the benefits that the countries would get from a successful customs union:

  1. Elimination of transactions costs: with the pillars of a currency union like single currency, some transactional costs and commissions of a non custom area will be eliminated; this helps developing and small economies to save in larger amounts and they are able to enjoy consumption gains and higher output.
  2. Foreign exchange risk is removed: with an effective monetary union, chances that a trading partner is going to suffer from foreign exchange losses are minimal; with a single currency, the rate of competitiveness among countries is also enhanced (Kanen, 1996).
  3. A transparent pricing system is created making international price comparison easier
  4. Countries become less vulnerable to tentative attacks.
  5. A currency union reduces chances of uncertainty where a trader is not sure of the rate at which he or she will be trading; with the uncertainty removed, then trade is facilitated.
  6. A currency union has the potential of freeing idle reserves ; when the reserves are traded with, then a country is able to benefits from the benefits of lying resources, the end result is an increased economic growth
  7. A currency union reinforces discipline and credibility in inflation-prone countries. It ensures that inflation rates are similar in all member countries and provides mechanisms for dealing with high inflation rates.

A more recent study conducted by Rose (2000) shows that most of the benefits of a currency union are associated with development of bilateral trade among member countries. Rose found out that bilateral trade among countries that have formed a currency union could increase significantly once the union is formalized.

There are also costs associated with the adoption of a single currency. This includes costs incurred in forming a currency union, and surrender of the monetary autonomy. Once a currency union has been established, exchange rates are fixed irrevocably against each other; foreign interest rates are used, implying that increases in money stock may result in deficits in balance of payment.

A country’s monetary policy helps in stabilizing economic adjustment but this role is constrained once a currency union is formed. Countries are forced to give up their monetary policy instruments and may result in employment losses as well as loss of output (Peterson, 1988). However, these costs depend on the flexibility of factor markets, if the flexibility is low, costs tend to increase and the opposite is true.

This is because low flexibility of factor markets creates a difficult situation for the adjustment of shocks. Other costs linked are to a likely split down of the currency union. It is not always the case that a currency union will be successful because there are instances where it may fail to work. If this happens, member countries can be affected greatly and they can loss a substantial amount of their output.

Costs and benefits of Gulf currency union to Saudi Arabia

With the development of Gulf currency union, the countries have had increased benefits that outdo the costs incurred as a result of the system. Nonetheless, there are some promising benefits that GCC countries stand to gain from a single currency. The following are the main benefits from the union:

Bargaining power: when trading as a block, the countries are able to negotiate better trading terms with other countries; on the other hand, they are able to improve their quality to fit the needs of the people. This means that, gulf currency union is going to pave the way for the GCC members to access more markets within themselves (Tenreyro, 2001).

More intra-trade: presently, most of the GCC countries, if not all of them, are planning to diversify their revenues by developing the non-oil sector.

This might even become easier with a single currency and trade between countries might become cheaper. In this respect there seems to be a bright future for the GCC members, especially in regard to intra-trade, once the new single currency is formalized. This is expected to create more business cycles, which will facilitate the establishment and acceptance of a common monetary policy (O’Sullivan, 2008).

Increase in economies of scale: a single currency is expected to increase the volume of trade, if this happens, producers are likely to enjoy increased economies of trade. This is because once a single currency is adopted trade barriers will be dismantled and the GCC countries will be able to access market in any of the member country. Along with increased economies of scale brought about by a single currency, monopolistic practices are likely to diminish leading to increased competition which in turns results in reduced prices on many products.

In such a situation, prices are set by forces of demand and supply where the intervention of the government is minimal; with such trading policies, competitiveness is enhanced. The adoption of a single currency would promote regional competition among the GCC members and this might improve the quality of services offered in these countries (O’Sullivan, 2008). When attained, there would be much service diversification that would eventually benefit the member countries.

Foreign exchange reserves: with an effective currency union, there will be no need to have foreign exchange reserves as the common currency can serve the role of the reserve; with less demand for foreign reserve, the countries will have checked their balance of payment deficit (Tenreyro, 2001).

Presently, most of the GCC countries are using the US Dollar as a common peg to their currencies. This was adopted in order to eliminate exchange risk and create more flexibility in international market. For this reason, GCC countries are forced to keep aside some reserve amount of US dollar to be used in their transactions. The establishment of a single currency would eliminate the need to keep the reserve amount for settling transactions.

With a custom union, there is elimination of currency exchange risks, this is facilitated by the fact that the countries are working with a similar financial setting and currency, financial institutions and financial policies are harmonized.

Increased investment opportunities: once the Gulf currency union has been launched, the GCC domestic and foreign investors will be able to make more economic prospects. This would be facilitated by lowering search costs, reducing the administrative procedures, and increasing the market size (Peterson, 1988).

When in a customs union, there is need to have an integrated financial sector where policies can move freely across the nations; such integration forms the background and infrastructures of development, enhances transparency and financial discipline; the harmonized systems assist in attracting foreign income (O’Sullivan, 2008).

A disciplined economic policy: when the union is operating, there are some rules, regulations and guidelines that are aimed at creating an environment of discipline and state respect; when such policies have been attained, and then the countries can maintain their solemnity.

Elimination of foreign exchange risk: According to O’Sullivan (2008) the adoption of a single currency would get rid of the foreign exchange risk in major countries. Economists are of the opinion that using foreign exchange risk management parameters hinder the growth of international trade.

With a single system, then the development of financial institutions like banks, insurances, bond and stock markets will be enhances; in addition, full integration will be achieved which may result in a constructive effect in monetary and fiscal policies that will instill lucidity and financial regulation in the region; this is an essential provision for financial constancy in the region.

Costs of the Gulf currency union

In a fully operating customs union, each country is expected to surrender and do away with its currency and adopt that of the union; such moves are likely to be taken negative by different countries as they feel their autonomy has been denied. Such decisions shift to the newly established central bank and the responsibility of national central banks reduces. The pegged exchange system operated by GCC countries has been an effective way through which they are able to control costs as it allows a narrow room, for manipulation.

Increased unemployment rate: There is also the possibility of increased unemployment rate within the countries in the region when a single currency is adopted. This would be caused by assumption of low inflation and external surplus, which is believed to stabilize the economic conditions within the region in one hand while on the other hand; this could cause a long-run problem.

When a currency union is established, some of the responsibilities of the central bank are rendered inactive. This means that the national central bank cannot interfere with the policy or alter the exchange rate in any circumstance; this creates unemployment since some workers, for instance monetary policy makers, are rendered unproductive.

Impacts and effects to Saudi Arabia

Saudi Arabia dominates the process of crafting a common currency for the GCC countries. However, if it is to succeed in its efforts it has to improve its relationship with other GCC countries, especially the smaller ones. Saudi Arabia is the biggest exporter of oil in the world and has the biggest economy in Arab state. It aims at creating an organized Gulf political in addition to an economic bloc that it can be able to lead.

The economic bloc is expected to counter the effects of Iran (one of Saudi Arabia’s rivals). However, Saudi Arabia’s dominance on the monetary union with the intention of creating a single currency for the GCC poses some risks adding to the discontent of other GCC members. For instance, UAE and Oman have already withdrawn from the union and this has shaken the progress toward the Gulf currency.

There is evident that Saudi Arabia will dominate the union once it is established and will in due course gain political influence over other Arab states. Although many researchers see this as being natural, it is the major source of the problems that exist between Saudi Arabia and other smaller GCC countries linked to sensitivity and mistrust. Some of the smaller countries hold the belief that Saudi Arabia (the big brother) is using its position to dominate them.

However there are still some countries that back up the decision of Saudi Arabia to dominant the other GCC countries on the view that it has a huge native population and has the ability to look after the interests of Gulf Arab. In addition, it has a high concentration of indigenous labor force and a stable monetary system that it can use for the benefit of other GCC countries once a single currency is established.

Nonetheless, Saudi Arabia may not be able to achieve its full potential due to increasing rates of inflation. Since 2006, the inflation rate has been on the increase and this is expected to increase even further in the near future. Appendix 7 shows the interest rates on a yearly basis from 2002 to 2007.

It is evident that the Saudi Arabia will reap many benefits once they abolish their national currencies and adopt a single one. However, the main question still remains, are the GCC countries ready for a single currency? Have their fulfilled all requirement for a currency union? Are they ready to surrender their monetary policy and accept a common currency? These are some of the issues addressed in this paper. By looking at the OCA criteria, it will be easy to assess whether the GCC countries are ready for a currency union or not.

Optimum Currency Area (OCA)

It is imperative to define what an OCA means for the purpose of easy understanding. An OCA can be defined as a region that is fit to have a common currency and have its own policies.

In other words an OCA can be referred to as a Currency Union. An effective OCA operates a similar currency and to some extent there is similar central bank monetary policies; its is a region that has achieved monetary integration, meaning that exchange rates can be fixed irrevocably, currencies can be converted easily, and there is financial market integration (Kenen, 1969).

Readiness of countries to form a currency union is measured based on how integrated the countries that are willing to form a single currency are within one another. This is evaluated in terms of trade, business correlations and other economic relationships. Over the last three decades, many countries have expressed their interest in forming economic integration and Currency Unions.

This can be dated back to 1961 when OCA was established by Mundell. According to Mundell, observed that in the case that the world is composed of different economic regions, then there would be an increased demand to have unique currencies that define a certain region (Mundell, 1961).

His view was that, if a shock hit any of these regions, factor mobility would adjust this condition and the region does not have to rely on the flexibility of its exchange rate. On the other hand, if factors of production are immobile, flexibility of the exchange rate alone cannot be able to stabilize the situation due to different rates of unemployment and inflation.

This assertion shows the usefulness of a common currency in different regions for adjusting market imbalances. According to Leefthink (1995), a currency union is affected by the rate of openness among the member countries and as well as the relation that the member countries create with the outside world; he further noted that exchange rates can only be used effectively to adjust external shocks if the economy is relatively closed (Setser, 2007).

OCA criteria

There are several aspects that have been developed to assess a country’s readiness in joining a currency union. Most of these aspects are based on characteristics that make currency unions and exchange rates extra attractive. The criteria include:

Openness- the paradigm of openness is aimed at protecting small trading countries whose economies are largely dependent on international trade; according to the structure, in the case of some trade irregularly, then the country is prone to suffer.

In such as case exchange rate cannot be relied upon to correct deficits or surpluses in balance of payment (McKinnon 1969). In this sense, the exchange rate becomes an unsuccessful tool for improving a small economy’s competitiveness in international market; this necessitates for an open policy economy.

Factor mobility- as seen earlier, the mobility of factors of production determines the success of a currency union. When factors of production are perfectly mobile, then there are chances of replacement where labor can be substituted for capital or vice versa (Kenen, 1969). In this case, factor mobility acts as a substitute to the exchange rate, that is, it acts as an adjustment tool to an economic shock. It can be concluded that countries whose factors of production are mobile can enter into a currency union.

The graph below shows the varying GCC Exchange Rates Paths against the US Dollar; this is one of the challenges that the economies are having since the rates vary with the strength of the country.

Graph 3

GCC Exchange Rates Paths against the US Dollar

GCC Exchange Rates Paths against the US Dollar

Degree of commodity diversification- the rate of economic diversity that a county has affects its absorption rate of trade deficits and deficits in balances of trade; more diversified countries have less trade deficits handles to deal with than those who depend on a single commodity. This is a good aspect for countries who have expressed the intention to enter into a currency union.

Similarity of production structure- in the case something happens in a certain area or a certain production line, the effect can be felt across board, with this notion, there is advocacy that countries would try to make a number of products. This can be caused by fluctuation in oil prices in the international markets. Therefore, countries that have similar production structure are good candidates for currency unions

Price and wage flexibility- the more flexible prices and wages are in a certain country, the less the need for altering the exchange rate in case of a shock. Such a country is likely to be engaged in a currency union that limits the use of exchange rate to alleviate against the impact of shock. Therefore flexibility in prices and wages in a country creates a good candidate for a currency union (McKinnon, 1963).

Similarities in inflation rate; when countries have a similar inflation rate it means that they have similar policies that affects demand and supply of their goods; these countries are good candidates for a currency union because they can coordinate their policies to suit the currency union requirements.

Degree of policy integration- a country that exhibit high degrees in policy integration is likely to succeed in entering into a currency union because it can be able to achieve monetary integration that is a requirement in the union (Eichengreen, 1996).

Political factors- the influence of politics I the making and maintenance of an economic union cannot be ignored; for a country to be considered as a good candidate for a currency union, it must portray its political willingness to achieve the goals of the union.

These are the main factors that are considered when determining the readiness of a country to enter to a currency union. Most of the aspects are based on the degree of dependence on the foreign exchange rate to control economic shocks. The less dependent a country is, the more easily it can enter into a currency union. The following section will test the readiness of GCC countries for a currency union.

Saudi Arabia readiness for the union

There are some factors that need to be considered when gauging whether the GCC countries have fully matured to form a custom union; this section discusses some of the main parameters to gauge the readiness.

Openness: Statistics have proved or suggest that in the entire Arabic nations, those nations having part at GCC have the best integrations and openness; the openness has a focus on the ration of trade to countries GDP (Yeyati, 2001). Table 2 (Appendixes) below shows the openness measures for the different countries that comprise the GCC; the measures may vary across economies.

High ratios are also shown by countries that rely heavily on imported goods because of the limited availability of domestic substitutes (Buiter, 2008). These factors constraint the use of exchange rate as an adjustment tool; please see the appendix 2 for an analysis of the openness among GCC countries.

Factor mobility: there is free mobility of factors of production, capital and labor, within and across the GCC countries. These countries have also been granted freedom in exercising economic activities.

One of the main hindrances to total labor mobility is joint ventures and labor movement among GCC countries; there are still some restrictions on ownership and business activities that can be exercised by GCC nations.

More to that, GCC countries have dissimilar labor market regulation and instructions that hinders the effectiveness of factor mobility (Eichengreen, 1996). This is not a good aspect for countries that have the intention of forming a currency union.

Degree of commodity diversification: Saudi Arabia is working hard to look for means to diversify their products; however this has not been attained to a large degree. These countries rely heavily on oil export; this represent approximately 80% of all the exports in GCC countries.

Table 3 (in the appendixes) gives the oil revenues to total revenues in the GCC countries. The table shows how GCC countries are highly dependent on export as compared to other exports. With the minimal diversification as experienced in the GCC, the countries suffer from external shocks and economic fluctuations

Similarity of production structure: the countries have rich oil reserves thus it has much concentration on the sector and leaves the non oil industry to exporters to the country; the limited in diversification makes the nations vulnerable to symmetric shocks. Saudi Arabia prefer to trade with other international countries rather than their fellow GCC members because they produce highly competitive products rather than complementary products (Leeftink, 1995).

Price and wage flexibility: wages and prices in the countries seem not to respond to changes in oil prices; instead government expenditures are used to stabilize the market in case of recessions. The limited use of prices and wages to act as an adjustment mechanism in times of shocks limits the preparedness of GCC countries to enter into a currency union (McKinnon, 1963).

Similar inflation rates: Saudi Arabia experience low rate of inflation most of the time; however, the prices follow the trend through which prices of oil adopt. Inflation rates are not correlated across GCC countries irrespective of similarities in most of the economic policies across these countries.

Such as the fiscal and monetary policy GCC have a different trend and system of inflation where some countries have a higher one than others, such a trend proves that despite the general believe that they share all things, there are some others that are not shared and affect demand and supply differently (Buiter, 2008)..

Degree of policy integration: the countries have entered into agreement to form similar regulations to guide them on economic and financial affairs. It could be argued that, GCC countries have already formed common policies and thus fulfilled the requirement for joining a union in regard to policy integration. For instance, they have common exchange rate policies that are centered on sustaining a wedge linking domestic and foreign interest rates for stabilizing exchange rate (Setser, 2007).

Political factors: GCC leaders are committed in ensuring that peace in maintained in this region. They hold meetings regularly to address issues related to economic integration and what needs to be done to achieve full integration.

When political factors are fully addressed, the countries expect to share common political, social, and cultural structures that can facilitate the growth of a union with some mutuality amongst themselves (Laabas & Imed, 2002). In spite of the fact that, the GCC countries have experienced many setbacks in their move to form a currency union, this has not affected the determination of GCC leaders to strengthen cooperation and achieve political integration.

Even if this integration is not moving as expected, many people praise GCC countries for the approach they have taken in reinforcing commonalities. It could therefore be argued that Saudi Arabia have already fulfilled the political criteria for joining a currency union although it still have some issues that need to be addressed (Masson & Pattillo, 2001).

Generalized Purchasing Power Parity Approach; according to supporters of the approach, they are of the opinion that PPP depends on some parameters that keeps changing across time and space; with this notion, then there should be no expectation that real exchange rate will be stationary.

The idea and the ideology brought about by Enders and Hurns is based on the fact that factors that affect exchange rate keeps changing thus having an assumption that the rate will remain unchanged is taking the wrong approach to the whole issue (Enders & Hurn, 1994).

Symmetrical shocks and convergence are sufficient tests that must be available in countries that have attained currency area status. All the GCC countries experience symmetrical shocks and this is highly influenced by the dependence on oil and gas. There are also convergence and they are therefore good candidates for a currency union (Berengaut & Elborgh-Woytek, 2006).

The above factors can be summarized in table 4 (in the appendixes) to show how eligible GCC countries are for a currency union

Judging from the criteria discussed above, Saudi Arabia have not fulfilled all the factors required. Some factors are still unfavorable for currency union; the above notion should not be taken to mean that the GCC have minimal chances of becoming a fully pledged customs union. As a matter of fact, one of the most recognized monetary union (EMU) carried through even when few of its members did not meet the optimality criteria.

Eichengreen (1990) notes that, some of the European countries that use the euro have fulfilled fewer conditions required for currency union than the GCC countries. The main problem associated with failure to fulfill all of the OCA criteria is that of increased costs of forming the union. If this is the case, members of the union might not be able to reap some of the benefits that are brought about by a currency union (Mundel 2000).

Methodology

This chapter will focus on how concentrates on different methods and procedures that were used to collect, analyze and make inferences in the research; it will also discuss a full description of research methods used, different techniques employed and give a justification of each method adopted.

This research employed the use of qualitative and quantitative research methods since other than offering the situation, the paper was interested in finding the impacts and effect of Gulf currency union. Qualitative is a method more common in social sciences and marketing studies. It is used to understand human behavior and the reasoning behind the behavior; in this case, the method will assist in determining the impact that a custom union will have on micro and macro-economic variables of the GCC countries.

Focusing on macroeconomic and microeconomic parameters will give the researcher the required information. To collect data, qualitative research methods use the following methods of data collection interviews, focus groups, cases studies and much effort will dwell on use of survey, it is not limited to the above methods.

One element that supports qualitative research method is the use of deductive reasoning when collecting data and information about the matter at hand. Deductive reasoning method is a systematic method of obtaining knowledge where one proceeds from a general point of view to a specific analysis.

The researcher starts from the known to explain the unknown. It provides a means of testing validity of a conclusion by having major premises and minor premises. The known facts are that there are some unions that are benefiting their members through economic, political, cultural, and social integration (Laabas & Imed, 2002).

Survey method of data collection

To collect data, this research used a survey data collection method supported by wide literature review. Survey is data collection methods were questionnaires and/or statistical surveys are conducted on places that will offer quality information about the topic at hand. The main areas that the information was collected were from economic scholars who head different organizations and Saudi Arabian economics scanners.

Since the research was based on survey method of collecting data, the sampling methodology adopted is that survey sampling method; in specific, information was collected from three main categories as of domestic private and public companies, governmental institutions, and the second batch was composed of internationals and Non-governmental organizations.

The survey was conducted to access the suitability of the Middle East market. Members from nine Middle Eastern countries were interviewed regarding their views and feelings regarding the preparedness of GCC members for a currency union. According to the survey, 54% of the respondents held the view that the GCC countries should join a currency union, 56% believed that a currency union would help the region in terms of economic integration (CFA Emirates, 2011).

The survey found out that there is a significant demand for lucidity in the business community and this requires increased assistance in crafting the monetary transition. Interviews conducted all over the GCC countries on the Secretariat officials reviewed that preparations for the Gulf currency were on the right track, while other economists differed with this assertion arguing that the process of preparation was too slow and the deadline would not be met.

In overall the respondent of the survey were optimistic in view of a common currency as over 50% felt that a currency union would be a good move for business in all the GCC members. More than 75% of the businesses interviewed believed that the region would benefit from a single currency since intra-regional trade would be harnessed between the GCC countries, it would become easier for the GCC to operate in neighboring countries and foreign direct investment would be increased (CFA Emirates, 2011).

Research design

Researchers use survey method to collect data from a large population; when suing the method, the sample population is selected from the larger population and data collected from them. To be able to generalize the information, there is need to analyze and interpolate the collected data effectively.

In this research majority of the data collected was qualitative and in statement form, the researcher grouped similar information in the same group bundle, and then compared the flow of information. It is important to note that data was collected from experts and economies that had wide and deep understanding of the matter.

With that source of information, the writer used inductive reasoning processes to interpret and structure the meanings of the data collected; the interviewees discussed the issues from what had been documented in GCC customs Union preparation meetings.

The design that has been used in the research was process onion approach as presented by; the method was superior as it offered a suitable research approach that doable the strategies of this study. The first layer raises the question of the research philosophy to adopt; the second layer flows from the first layer and considers the subject of research approach that was adopted in the research.

The third layer portrayed the research strategy followed by the forth layer which was more concerned about time frames that the researcher used when conducting the research; the final layer (fifth layer), the approach provided for data collection method that were employed in the research.

The approach was systematic to ensure that data and the situation on the ground was well understood to offer a background for recommendation and conclusion; with a sound understanding of what is happening on the ground, Saudi Arabian preparedness and net effect after the GCC union can be well interpolated.

Ethical issues within the research design and conduct of the research

Informed consent and confidentiality

The data collected needed to be treated with privacy and protected the identity of the companies that were used; it was taken as their mere believe and opinion thus was treated with the respect that id deserved. Disclosures that be at their own free will and should be given the right of information protection and security.

Despite protecting the information offered, to avoid the ethical problems encountered, the researcher informed the participants of areas that might touch their company’s lives or competitiveness and offered them free will to disclose or hold the information; when the information was disclosed, it was kept under privacy and confidentiality

Area of study

To assist in collection of data and information, the area of primary data collection and analysis was chosen to be the Saudi Arabia with the researcher concentrating on companies situated at Riyadh, Asir and Qarim for interviews with business executives’ economists, and government officials.

To reach other areas in the country, the researcher sent questionnaires to people living in different cities using mails and emails; the questions were inclined to go in line with the research questions but since the country has different people of different backgrounds in race, education, and economic standing, different approaches will be made. Efforts were made to ensure that the answers given are objective and the respondent never felt that they are being interrogated; data to the extremes was trimmed off the analysis stage

Result, findings and discussion

Over the last three decades, the states of Gulf Arab have made a lot of efforts towards a common currency. The Gulf Cooperation was formed in 1981 for this purpose alongside other policy issues. Since then, GCC leaders have been holding meetings regularly to discuss the way forward toward a currency union. However, just like other unions that have been formed in the past, for instance the European Union, the road to a single currency has been with many challenges.

This is because there are a lot of factors that have to be looked into before a country can enter into a currency. First, countries in the region that have expressed interest in currency union have to show solidarity in their activities. OCA criteria have been approved as one of the best assessment criteria to test the readiness of a region for a currency union. According to these criteria many conditions have to be fulfilled by a region before it is allowed to form a currency union.

These factors have been used to test the readiness of GCC countries for a currency union. The first criteria require all countries within a region to have complete mobility of factors if they are to enter into a currency union. By looking at the GCC countries, they seem to have fulfilled this criterion although factor mobility is still limited but it is expected to improve once a currency union.

OCA criteria require countries to have diversified economies if they are to succeed in a currency union. This is not the case for the GCC countries whose economies are highly dependent on the oil sector. The non-oil sector is very limited and a lot of efforts have to be taken on this sector to ensure that there is diversification in the GCC countries.

However, this might take a long period of time given that oil revenues contribute the biggest percentage of total revenue, and the fact that GCC countries have the largest number of oil and gas reserves. Nonetheless, the diversification process may be accelerated by external pressures, for instance, the increase in oil production from other parts of the world and the search for alternative energy sources which are currently going on in many parts of the world.

Others factors that are considered in the OCA criteria are similarity in inflation rates, openness, degree of policy integration, similarity in economic structure, among others. When the GCC countries are tested against these criteria, it is clear that, there is much to be done before they can be considered as an optimum currency area. However, this does not mean that GCC cannot enter into a currency union. Research has found out that one of the widely recognized monetary unions, European Union has not fulfilled all of the OCA conditions.

As a matter of fact, the GCC countries seem to have fulfilled a bigger number of conditions than the European countries. This means that the GCC countries are on the right path toward a common currency, although the process may be hindered by other forces within the cooperation. For instance, the cooperation has not yet established a common central bank and it does not seem to have a clear timetable for the currency union.

Once a currency union has been established, Saudi Arabia stands benefits from an increase in bargaining power, greater access to international market, increased intra-regional trade, increase in economies of scale and diversification of economies. However, there are also costs associated with this move.

After establishing a currency union, the GCC countries will have to give up their monetary policy and adopt a common policy. Some of the responsibilities of the national central banks will be shifted to a common central bank; this means that, the GCC countries will have to rely on a common central bank for adjustment in case of shocks or market uncertainty. They will also have to give some of their national privileges for the good of the whole region.

Conclusion

Through economic integration, nations get a wider access to the world economy and their dependence on local resources is reduced; the GCC have the potential of being economic drivers when they are acting as a block; when a block there is no restrictions to trade or W.T.O. (World Trade Organization) where trade is regulated by an internationally body.

With the integration, Saudi Arabia is likely to be one of the main beneficiaries of the union as it controls a substantial amount of GCC economies; the benefits can be classified as economic benefits, social, political, and environmental benefits. Economic integration makes international trade easier through the removal of trade barriers and tariffs; facilitated trade is one major basis of economic growth and cooperation among countries; it can also be through protection of investors in order to promote their capital investments.

With economic integration, good and services, labor and capital find their way in the country where they can be put into maximum use; the GCC countries have resources that have not been fully utilized, with the making of custom union, the resources will be fully used for their benefits.

Despite the benefits expected to accrue to the Saudi Arabia, to accommodate the union, there are some adjustments it has to make to their economy, they include reduced autonomy and acceptance to share its resources with the union members. On the other hand, free flow of goods, services and factors of production is likely o increase competition to domestic Saudi Arabian markets; the competition may extend to labor market, product, and service market.

References

Berenguat, J.,& Elborgh-Woytek, S. (2006). Beuty Queens and Wallflowers-Currency Maps in the Middle East and Central Asia. IMF working paper No. 06/226. Washington: International Monetary Fund.

Buiter, W. M. (2008). Economic, political, and institutional prerequisites for monetary union among the members of the Gulf Cooperation Council. CEPR Discussion paper No. 6639. London: Cebter for Economic Policy Research

CFA Emirates (2011). First Middle East market sentiment survey unveiled. Bahrain, Egypt, Jordan, Kuwait, Lebanon, Oman, Qatar, Saudi Arabia, United Arab Emirates. Print

Eichengreen, B. (1996). A more perfect union? The logic of Economic Integration, Essays in international finance, No. 198, June. Department of Economics, Princeton University. New Jersey: Princeton.

El Kuwaiz, A. I. (1988). Monetary Integration in the GCC countries” In Henry Azzam “Gulf Financial Markets. Bahrain: The Gulf International bank.

Enders, W. & Hurn, S. (1994). Theory and test of Generalized Purchasing-Power Parity: common trends and real exchange rates in the Pacific Rim. Review of international Economics, 2(2), 179-190.

Kenen, P. B. (1969). The theory of Optimum Currency Areas: An Electic View. New York: Jersey.

Laabas, B. & Imed, L. (2002). Are GCC countries ready for Currency Union?. Kuwait: Arab Planning Institute.

Leeftink, B. (1995). The Desirability of Currency Unification: Theory and Some Evidence. Amsterdam: Thesis Publishers.

Louis, B.,& Osman, A. (2008). Monetary Union among Gulf Cooperation Council (AGCC) countries: Does the symmetry of shocks extend to the non-oil sector?. New York: Munich Personal RePEc Archive.

Masson, P. & Pattillo, C. (2001). Monetary Union in West Africa (ECOWAS): is it Desirable and How Could It be achieved?. New York: IMF Occasional paper

McKinnon, R. I. (1963). Optimum Currency Areas. American Economic Review, 53(1), 717-725.

Mundel, R. A. (1961). A theory of Optimum Currency Areas, American Economic Review, 51(1), 657-665.

Mundell, A. K. (2000). Monetary problems of the international Economy. Chicago: University of Chicago Press.

O’Sullivan, E. (2008). The New Gulf: How modern Arabia is changing the world for good. Dubai: Motivate Publishing.

Peterson, E. R. (1988). The Gulf Cooperation Council: Search for Unity in a Dynamic region. Boulder : Westview Press.

Rose, A. (2000). One money, one market: Estimating the effect of common currencies on trade. Economic policy, 30(2), 7-45.

Setser, B. (2007). The case for Exchange rate flexibility in Oil-Exporting Economies. Peterson Institute for International Economics Policy Brief 17-8. Washington: Peterson Institute for International Economics.

Sturm, M. J. et al, (2008). The Gulf Cooperation Council Countries: Economic structures, Recent Developments, and Role in the Global economy, European Central Bank. Frankfurt: European Central Bank

Tenreyro, S. (2001). On the causes and consequences of currency unions. Department of Economics. Harvard: Havard University.

Appendixes

Appendix 1

Table 1: Average Growth Rates of Nominal GDP

Period Bahrain Kuwait Oman Qatar SA UAE GCC average
1970s 25.1 30.6 46.4 31.3 47.7 51.1 38.7
1980s 3.0 -3.3 7.1 0.1 -2.5 2.1 1.1
1990s 6.6 11.3 5.9 10.3 5.2 8.0 7.9
2001-2007 13.9 17.3 10.9 20.8 10.8 15.7 14.9

Source: United Nation statistics Database

Appendix 2

Table 2: Openness of GCC countries

years Bahrain Kuwait Oman Qatar S. Arabia UAE
1980 226.50 90.00 84.56 90.90 88.98 96.05
1985 169.03 75.63 77.14 68.86 52.66 69.30
1990 164.21 56.50 67.67 70.98 65.47 83.28
1995 131.97 77.46 68.67 70.98 65.47 83.28
1996 145.59 75.89 71.63 73.08 62.62 85.69
1997 130.98 74.53 71.77 62.97 61.06 89.17
1998 109.40 72.46 70.03 74.23 55.50 87.02
2003 128.5 66.1 85.5 76.9 62.9 134.0
2004 133.0 69.4 89.4 77.1 69.3 152.0
2005 145.9 75.1 89.5 83.4 76.1 145.2
2006 150.7 70.5 91.3 88.9 78.8 149.7
2007 136.2 76.6 101 90.1 84.3 164.3

Openness = {(exports + imports of goods)/GDP) *100

Source: National Central Banks

Appendix 3

Table 3: GCC oil revenues to total revenues (%)

country 2003 2004 2005 2006 2007
Bahrain 73.0 72.6 75.7 77.1 80.1
Kuwait 88.7 91.2 94.4 93.6 93.1
Oman 70.1 71.9 70.1 64.8 62.1
Qatar 64.1 66.0 67.1 64.6 60.7
SA 78.8 84.1 89.4 89.7 87.5
UAE 73.7 77.4 69.4 81.9 77.1

Source: National Central Banks

Appendix 4

Table 4: GCC countries eligibility test for OCA

OCA criterion Favorable Unfavorable
Openness
Factor mobility
Commodity Diversification
Product structure
Price and Wage flexibility
Similarity of inflation rates
Degree of policy integration
Political factors

Appendix 5

Table 5: Correlation coefficient of output growth (1970-2007)

Country Bahrain Kuwait Oman Qatar SA UAE
Bahrain 1.00
Kuwait 0.66 1.00
Oman 0.95 0.52 1.00
Qatar 0.97 0.74 0.91 1.00
SA 0.95 0.47 0.91 0.88 1.00
UAE 0.98 0.57 0.95 0.95 0.97 1.00

Sources: United nation statistics Database (GDP at constant 1990 prices)

Appendix 6

Table 6: Inflation rate in GCC

Year Bahrain Kuwait Oman Qatar SA UAE
2003 1.6 1.0 0.2 2.3 0.6 3.1
2004 2.2 1.3 0.7 6.8 0.3 5.0
2005 2.6 4.1 1.9 8.8 0.7 6.2
2006 2.0 3.0 3.4 11.9 2.2 9.3
2007 3.3 5.5 5.9 13.8 4.1 11.1

Source: Secretariat General of GCC countries, statistics Database

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