Central Bank for GCC - Research Paper Example

?Central Bank for GCC Executive Summary The Gulf Cooperation Council (GCC) consists of six countries, Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates. The study focuses on role of the central bank proposed to be established by the GCC countries, arguments for and against the GCC central bank and appropriate structure of the central bank taking into account the unique features of the GCC economic zone. The proposed bank is compared with European central bank established for countries in European Union for better understanding of the factors involved in establishing monetary integration. The important objectives and functions of the proposed GCC central bank are discussed in the backdrop of role of the central bank in general and with particular reference to GCC countries. Introduction International financial crisis in the recent years calls for monetary integration and regional cooperation of the countries for efficiently dealing with the crises and protecting the interests of the member countries. The monetary policies of a central bank plays pivotal role in regulating interest rates and inflation in the countries with a view to ensure economic growth. The monetary policies of a central bank have impact on various economic factors such as employment, liquidity in the system and stability of the currencies. Central bank proposed for the GCC countries aims at financial stability in the GCC countries with a view to reorient the strategies of the group countries in response to the dynamic international economic situation and to promote economic cooperation among the group countries. Therefore, the structure of the central bank should be designed to achieve these objectives in relation to the group countries. Arguments for & against GCC Central Bank According to Al-Bassam (2013, p. 105-106), ‘Their peoples share a common language, religion and traditions... There appear to be no major conflicts about policy objectives…’ Monetary union eliminates transaction costs involved in bid-ask spreads. Foreign exchange risk avoided within the region in this process benefits trade. Pricing of products becomes more transparent and results in healthy competition. Monetary union will be stronger to deal with speculation in the market. Under the monetary policies of GCC central bank, stability in exchange rate could be achieved. The member countries of GCC peg their currencies to USD and their interest rates are fixed based on the changes interest rates in US. Adjustments in interest rates in sync with US policy might have negative impacts on domestic economies of the GCC countries. Currency unification is expected to delink pegging of GCC currencies to USD. The member countries are not yet prepared for monetary union. There are differences in economic fundamentals among the countries. Trading and transactions within the region is very limited, and the countries are mostly dependent on oil exports. Lack of efforts towards economic integration and institutional development are the important drawbacks. The differences in the economic policies followed by the GCC countries would make the unification process difficult. Three different methods used to test the GCC economies by Abu-Bader and Abu-Qarn (2006), the Structural VAR, co-integration tests and common business cycles provide no support for establishing a monetary union (AlKholifey & Alreshan, p. 19). They also observed ‘that neither AD nor AS shocks are symmetrical between the GCC countries and the selected European countries’ (p. 20) while AD refers to Aggregate Demand and AS, Aggregate Supply. Structure of the suggested Central Bank for GCC Monetary union in GCC can stimulate uniformity in macroeconomic policies within the union and inter alia improve investment options and allocation of resources within the region. Fundamental factor involved in establishing central bank or monetary union is convergence of monetary, fiscal and structural policies of the member countries. According to Sturm and Siegfried (2005, p. 63), ‘monetary union requires a single monetary and exchange rate policy, which has to be underpinned by a supranational monetary institution at the GCC level.’ Obtaining clear mandate for the monetary union with necessary independence to ensure monetary stability within the region is important in finalizing structure of the central bank. Developing an organizational structure involves legal position of the central bank in relation to the member countries, ownership and voting rights, budgeting for GCC central and national central banks, making common monetary policy for the countries and operational procedures of the system. The Chairman and the governing committee, vested with the responsibility of overall management can be appointed by the GCC council with appropriate representation to the member countries. The major decision making bodies relating to various activities include: 1. Foreign exchange reserves to be maintained by the central bank, 2. Settlement of payments, 3. Exchange rate policy, 4. Operations of the national central banks, 5. Infrastructure for statistics and dissemination of information, 6. Supervision of banking regulations and 7. Liaison relating to unified currency with international monetary bodies. These bodies have to be established, and their authorities and responsibilities specified for effective control and coordination of the banking activities in respect of these functions depending upon the degree of centralization desired by the member countries and the status of the existing banking system. Comparison with European Central Bank Economic integration and monetary union in European Union have been considered successful on introduction of Euro. GCC council may have to closely watch the history of European central bank and develop its strategies in those lines for promoting GCC central bank after taking into account the special features of the economies of the member countries. ‘The Panzar–Rosse H-statistics suggest that banks in Kuwait, Saudi Arabia and the UAE operate under perfect competition; banks in Bahrain and Qatar operate under conditions of monopolistic competition; and we are unable to reject monopolistic competition for the banking market in Oman’ (Al-Muharrami, Matthews & Khabari, 2006 p. 3487) The council’s original plan to introduce single currency for the member countries by January 2010 could not materialize. ‘If realised, the GCC monetary union would be the second most important supranational monetary union in the world in terms of GDP and population, after the euro area.’ (7) High degree of monetary convergence existing in GCC member countries is an advantage in moving forward the proposal. Single currency will lead to faster economic convergence. Though comparison is difficult at this evolving stage, infrastructure in respect of statistics needs to be strengthened in GCC. Committee of the governors of national central banks should play a leading role in monetary integration as in the case of EU central bank. Establishing necessary institution like ‘ECOFIN’ in EU to support the central banking in GCC is necessary. ‘Progress has been made towards the implementation of these goals, and many measures have been taken to align their monetary, financial and economic systems as a prelude for a common currency to be introduced no later than January 2010’ (Abu-Bader & Abu-Qarn, 2006). Important objectives and functions of GCC central Bank Establishing single currency is the primary objective of establishing the GCC central bank. The GCC monetary union aims ‘to achieve a high level of financial and monetary stability, and create an economic bloc that is able to negotiate and compete on the international level…Such important projects will contribute to increasing rates of economic growth and employment, ease the transmission of investments between the GCC countries and attract foreign investments’ (Al-Assaf, 2013) Coordination among these countries in financial, monetary and banking policies creates synergy that will lead to sustainable economic growth and development of these nations. Apart from regulating interest rates and supply of money with a view to ensure economic growth of the members, the functions of the central bank include promoting employment, keeping inflation under control and maintaining stability in exchange rates through its monetary policies and regulatory powers. Conclusion Adoption of single currency in GCC countries can achieve creation of economic bloc for the benefit of all the GCC member countries. Establishing central bank by GCC is necessary for this purpose. Convergence of monetary, fiscal and structural policies of the member nations is a prerequisite for achieving this objective. GCC can gainfully adopt the methods adopted by European Union for formation of central bank by establishing appropriate organisational structure, taking into account the special features related to their economies and the existing banking system. References Abu-Bader, S. & Abu-Qarn, A. (2006) On the optimality of a GCC Monetary Union: Structural VAR, Common Trends and Common Cycles Evidence. Monaster center for economic research. Retrieved from http://mpra.ub.uni-muenchen.de/971/1/MPRA_paper_971.pdf Al-Assaf, I. A. (2013) GCC Monetary Council Headquarters Opens in Riyadh. Bahrain News Agency. 6 October 2013. Retrieved from http://www.bna.bh/portal/en/news/582972 Al-Bassam, K. (2013) The Gulf Cooperation Council monetary union: a Bahraini perspective Bank for International Settlements. BIS Papers No 17. Retrieved from http://www.bis.org/publ/bppdf/bispap17i.pdf Al-Muharrami, S., Matthews, K. & Khabari, Y. (2006) Market structure and competitive conditions in the Arab GCC banking system Journal of Banking & Finance 30 (2006) 3487–3501. AlKholifey, A. & Alreshan, A. (2009) GCC monetary union. Bank for International Settlements. IFC Bulletin No. 32. Retrieved from http://www.bis.org/ifc/publ/ifcb32b.pdf Sturm and Siegfried (2005) REGIONAL MONETARY INTEGRATION IN THE MEMBER STATES OF THE GULF COOPERATION COUNCIL. European Central Bank. Occasional Paper Series No. 31. 2005. Retrieved from http://www.ecb.europa.eu/pub/pdf/scpops/ecbocp31.pdf Read More