GCC States Learn Lessons From the Eurozone Crisis

With the gap growing in inflation and interest rates among GCC member states, Zakaa al-Khaledi writes that they must learn the lessons of the Eurozone to create the appropriate conditions for launching their own single currency.

al-monitor An illuminated euro sign is seen in front of the headquarters of the European Central Bank (ECB) in the late evening in Frankfurt, Jan. 8, 2013. Photo by REUTERS/Kai Pfaffenbach.

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gulf, gcc, eurozone, euro, economy, currency

Jan 29, 2013

For more than half a century, the European Union’s course of action has been the most successful global role model for regional integration. Therefore, the Gulf Cooperation Council (GCC) was expected to benefit from the European experience and study the requirements of each of its stages. Ever since the council took the decision to issue a single Gulf currency, while making great use of the European experience with the euro, it resorted to some of the clauses of the Maastricht Treaty, which had paved the way for the single European currency. After the emergence of the sovereign debt crisis in the EU and the subsequent doubts surrounding the position of the Euro as single currency, it was likely that this would affect the single Gulf currency plan.

Gulf leaders have, however, indicated in their statements that while the Euro’s situation might delay the single Gulf currency, it will not cancel it. They added that they are trying to benefit positively from the Euro crisis, in favor of their single currency. The difference between the conditions of the EU, on the one hand, and those of the GCC, on the other, are obvious. The sole similarity between them is the idea of integration. Therefore, after the issuance of their single currency, the Gulf countries are expected to face challenges that are very different from those associated with the Euro crisis today.

To achieve monetary unity between two or more countries, there are several important criteria to be met:

1.  Similarity between the trade or business cycles of the economies of the member states, in order to be able to apply similar fiscal and monetary policies;

2. Increased intra-regional trade compared with other countries;

3. Free movement of production factors, like work and capital, among these countries;

A study published by Kuwait National Bank in 2010 showed that the similarity between the economic shocks and business cycles of Gulf economies might disappear in the future due to the diverse economic policies adopted by member states. Consequently, different political and fiscal policies will be needed. If a monetary union is established, however, the member states can no longer apply different monetary policies and will have to comply with the policies of a common central bank. The main concern of fiscal policy, therefore, would be to focus on a way to coordinate between the independent fiscal policies of each member state. Since there will not be an independent use of monetary policy in the monetary union, fiscal policy will be more burdened with the decrease in the similarities between the trade cycles of member states.

The GCC Standardization Organization (inspired by the Eurozone countries) determined five fields that are necessary to achieve closeness between the policies of the different states: inflation rate, interest rate, foreign exchange reserves, annual budgetary deficits and public debt.

The budgetary deficit and the magnitude of the public debt are two important factors for the Eurozone countries, because their governments resort to borrowing money in order to fund spending.

Both the Maastricht and Lisbon treaties forbade governmental borrowing from the European Central Bank and focused on the importance of the limits that the annual fiscal deficit and public debt of each country must not exceed as a proportion of their gross domestic product (GDP). The influence on the economies of the Eurozone countries is expanding from governmental spending to the balance of payments. There are also concerns that the spending financed by borrowing from the financial system might affect monetary supply and balance of payments, thus shaking the stability of the euro exchange rate.

As for the GCC countries, the governments do not need to borrow money because they are rich in oil and gas resources and have huge monetary reserves. They are therefore not particularly concerned about setting certain limits for borrowing and forbidding borrowing from the common central bank. They already rely to a large extent on oil and gas exports, which provide governmental revenue. Therefore, fiscal policy is considered the main determinant of monetary supply, and the role of monetary policy becomes concerned with controlling monetary developments resulting from the increase in governmental spending. This is determined by external factors, demonstrated by the magnitude of the demand on oil and gas and their global prices.

Consequently, government spending is directly influenced by the state of the balance of payments, especially the trade balance. Then, the influence reaches government spending and monetary supply. The monetary surplus cannot be contained to prevent inflation, except through increasing interest rates. If these countries spend all their oil resources internally, they will have to apply different interest rates. Thus, they will no longer care about the size of the government’s deficit and its rate compared to the GDP or the public debts. Instead, they will be interested in the public spending of each member state.

The GCC countries must also stay away from the U.S. monetary policy and avoid applying American interest rates since they are not obliged to do so. They are not part of the U.S. in one currency area, as was the case with the Pound Sterling area previously.

Another challenge that the Gulf monetary union countries are facing is the difference of inflation rates among them. During 1997-2002, the annual inflation rate in the council was only 0.4%, while it witnessed a significant increase to 6.9% in 2007. The rate of increase was more than doubled between 2005 and 2007. After the difference in the inflation rates in the GCC countries was at its lowest (3%) in 2003, it soon increased and reached 10.4% in 2007.

The difference in inflation rates is expected to increase even more in the future, with the difference in the size of oil resources, and therefore government spending, and the unjustified connection between the interest rates in the GCC countries and the United States. 

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