By

Adnan Ahmed Qatinah

Mohammed Ghiath HASAN AGHA

Husam Al Dakak

Ala'a Mohamed

IS THE GCC AN OPTIMAL CURRENCY AREA?

ECONOMIC CHANGE IN THE ARAB REGION Economic integration

Contents• 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

IntroductionIn 2001, the Gulf Cooperation Council countries (GCC)

(Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab

Emirates) decided to introduce a common currency by 2010.

Furthermore, in 2005, the GCC members adopted the European

Union (EU) convergence criteria with respect to budget deficit,

public debt, currency reserves, interest rate, and inflation.

The main objective of our presentation is to

investigate to what extent the GCC member states meet the

theoretical criteria for an optimal monetary union.

The theory of Optimum Currency Area (OCA)

Mundell stated “economic efficiency would be

maximized in a geographical region if the region all

shared a single currency".

Professor Robert Mundell, 1999 Nobel Laureate: the father of the Theory of Optimum Currency Areas.

• The Gulf Cooperation Council (GCC) was established.1981• Free Trade zone was established to enhance economic

integration.1983

• Customs Union was established.1999• GCC countries pegged their currencies to the US dollar as

well as established a common external tariff of 5%2003

• GCC countries agreed to introduce a monetary union.2008

Overview of the economic cooperation in GCC

Overview of the economic cooperation in GCC

Period Bahrain Kuwait Oman QatarSaudi Arabia UAE

GCCAverage

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

Average Growth Rates of Nominal GDP

OCA criteria: Openness GCC economies cycles

Benefits and Costs for GCC to have OCABENEFITS

• Reduces transaction costs

• Bargaining Power

• More Intra Trade

• Economies to Scale

• Removal of Foreign Exchange Risk

• Fixed Exchange Rates

COSTS• Unitary Monetary Policy

• Constraint on national fiscal policy;

GCC and criteria of OCA• Openness

• Diverse Production

• Mobile Labor

• Transfer Criterion

• Homogeneity of preferences

• Solidarity vs. nationalism

OCA criteria: Openness

• 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/~mckinnon/

OCA criteria: Openness

The GCC economies have traditionally

been open to international trade in

goods and services. Asia and the

European Union have accounted for

about two-thirds of GCC exports and

imports.

2003 2004 2005 2006 20070

20

40

60

80

100

120

140

160

180

Openness degree of the GCC

Bahrain Kuwait OmanQatar Saudi Arabia UAE

OCA criteria: Openness

Intra-GCC trade has been low (less than 10

percent) due to the fact that all the GCC

countries are mainly oil producers and have

similar economic structures.

10%

90%

GCC trade in 2010

Intra-trade Extra-trade

OCA criteria: Openness Small open economies

CountryGDP

Bn USDTrade

Bn USDOpenness% of GDP

Intra-GCC% of trade

Bahrain 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, 2008.

OCA criteria: Openness

As far as the Mckinnon criterion is

concerned, most of GCC economies

qualify for joining a monetary union.

They are very open, they may will not

face asymmetric shocks.

OCA criteria: DiversificationKenen stated that countries with a wide range of

products and similar production structure are more

likely to form an optimum currency area with lower

probability of asymmetric shocks.

Asymmetric shocks are more likely to have greater

negative impact on countries with less diverse

production. Peter Kenen

Source: www.princeton.edu

OCA criteria: Diversification

Despite the efforts to diversify their

economies, GCC countries remain heavily

dependent on oil. Since 1991 oil and gas

income constituted, in average, 35 percent

of the GDP, 77 percent of total exports and

74 percent of government revenues.

OCA criteria: Diversification

CountryOil and

GasManufacturing Government

Financial services

ConstructionOther

servicesOther

Bahrain 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%

GDP shares by sector

Source: UNSD- Key Global Indicators, 2009

OCA criteria: Diversification

As far as the Kenen criterion is

concerned, most GCC economies

are qualify for joining a monetary

union, because, their economies

are similar production structure and

asymmetric shocks are not more

likely among GCC.

OCA criteria: Labor Mobility • 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

OCA criteria: Labor Mobility • 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

OCA criteria: Labor Mobility

Nationality Total

Kuwait 77Bahrain 633Oman 4,051Saudi Arabia 775United Arab Emirates 263Total 5,799

GCC National Working in Qatar (2010)

Source: Data Collected from Qatar Statistics Authority

OCA criteria: Labor Mobility

Bahrain Kuwait Oman Qatar Saudi Arabia UAE0

10

20

30

40

50

60

70

80

90

49.3

69

29.9

N/A

27

80.7

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.

OCA criteria: Fiscal transfers• 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.

OCA criteria: Fiscal transfers

Country 2003 2004 2005 2006 2007

Bahrain 1.8 1.4 5.1 2.3 0.6

Kuwait 10.0 15.1 29.1 17.6 29.7

Oman 1.4 2.4 2.5 0.3 0.3

Qatar 3.9 16.4 9.2 9.0 14.7

Saudi Arabia 45 11.4 18.4 21.7 14.6

UAE -4.5 -0.4 8.1 12.0 9.5

Budget Surplus/ deficit for the GCC Countries % to GDP

Source: Secretariat General of GCC, and Oman Central bank annual report

OCA criteria: Homogeneous Preferences

• 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.

Conclusion Criterion Satisfied?Openness Yes

Product Diversification Yes

Labor Mobility No

Fiscal Transfers Yes

Homogeneity of Preferences Yes

Solidarity vs. Nationalism No

OCA criteria: Solidarity vs. Nationalism

• 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.