Background

Members states of GCC : Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab
Emirates

What is the need of implementation of a common Monetary Union by GCC ?

GCC was set up in 1981. One of the motives of setting up GCC was to increase trade between
its member states [Greater Economic Integration].
At the end of 2007 to further the motive of Economic integration of member states of GCC, a
common market was formally agreed between the member states. Once the policy of common
market is implemented, it will allow free movement of labour, capital and goods between the
member states. For the proper functioning and implementation of the common market policy, it
was important to introduce a common currency which will help in eliminating the transaction
costs in bilateral exchanges between the member states. This will lead to greater efficiency in
economic transaction between the member states & will also help in economic integration of the
member states.
Formation of GCC monetary Union was seen to be essential to ensure enhanced economic
stability and economic integration of the member states.

Fixed Exchange Rate Regime of GCC

GCC follows a fixed exchange rate regime where the currency is pegged to the US dollar.
Oil is the chief commodity of export in GCC member states and oil prices are fixed in dollars (here
fixed means negotiated in terms of dollars). But, the decrease in oil prices has resulted in declining
revenues and current account deficits. The economic growth in US will be robust in the next few
years. The US economy is expanding but at the same time the GCC economies are contracting over
low oil prices and geo political instability. With the US economy expanding, it is gradually expected
to increase its interest rates. Decline in oil prices will also lead to currency depreciation in the GCC
member states. But, due to the substantial amount of FOREX reserves at the disposal of GCC
member states, they will be able to resist substantial currency depreciation for some period of time.
Although reserves ensure stability in the medium run but in the long run, currency depreciation will
lead to high rate of inflation. GCC banks in response to increase in rate of interest by US Federal
Reserve and to limit inflation will need to increase the interest rates. As a result growth and
investment will be negatively impacted.
[It is normally argued that depreciation in currency increases export competitiveness but this is not
likely to have a large impact on GCC member states due to following factors :
1. Equilibrium in oil market is set in international market
2. States like Iran, Venezuela , Russia also control substantial reserves of oil. In case of increase in
export competitiveness of GCC member states, these nations are expected to act counteractively
through their monetary policy to ensure that the advantage of GCC countries in export
competiveness does not last long ]
More over countries like Kuwait, Qatar, Saudi Arabia, and the United Arab Emirates may have
sufficient central bank reserves to withstand this period of currency depreciation and low
economic growth in the medium run but Oman and Bahrain do not have sufficient reserves for
them to last such a period of economic growth for more than 3-4 years.

2. Disadvantage of a currency union -

Member states of GCC will lose the ability of using an independent monetary policy to stimulate the
economy in times of asymmetric or unexpected shocks. There is a possibility that the economic
shocks may adversely affect some nations and not others. Such a scenario will further lead to
political instability and the reduced flexibility of the currency union will compound the effect of the
economic shock. There are further chances of instability in such a system owing to the fact that it
depends on how smaller nations are affected by such a system and how a dominant member exerts
its influence on other member states.

Conclusion
The current exchange rate arrangements of the Gulf Cooperation Council is not sustainable in the
long run as it is pegged against dollar which is although a credible anchor but still the economic setup
of the US economy is vastly different from the economic set up of GCC member states. So, certain
economic factors ( in this case oil price change) which may affect GCC member states in one way,
may affect US economy in the other way or its effect may be negligible. Macroeconomic adjustments
(rise in interest rates in this case) of US economy will be forced on the GCC monetary union which
may makes the matters even worse for the GCC member States. It is advisable that the GCC pegs its
currency against the currency of a nation which has similar economic conditions as that of GCC and
is stable in the long run.