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Unified single currency?


A day-dream of the Islamic world

Sep 10 - 16, 2001

The demand for one common currency for Muslim countries is gradually gaining ground. The dogma seems to have fascinated Muslim rationalists, who off and on issue statements supporting it as an anti-dollarization device.

Dr. Mahatir Mohammed, Prime Minister of Malaysia, is one of the most vocal advocates of financial oneness among Muslim countries. Recently, in his address before the Malaysian Parliament he urged upon the Muslim countries to adopt a single currency, which, according to him, would reduce their dependence on dollar, and help increase the trade between them. The observers, by and large, eulogized the P.M's single currency philosophy matching it with the advent of Euro.

Al-Baraka, a director of a Saudi financial group operating in Malaysia, himself being an ardent supporter of a single currency for the Islamic world, expressed certain reservations by way of hinting at some unspecified obstacles in the way of its implementation. However, he thought the Islamic Conference Organization could be of immense help in ground-breaking. Simultaneously, he observed that the volume of trade between Muslim countries is negligible, while the major trade partner of the most countries is the USA.

Since a debate on the issue has been set off, and as a call has been given to initiate the spadework, it is high time an objective analysis of the proposition is offered.

Monetary union

When two or more countries agree to a jointly managed monetary and economic policy, they are said to have been integrated into a monetary union. Minimum prerequisites of a monetary union are:

Single Effective Currency: There must be either one currency operating as legal tender in all the member countries or several currencies which are fully convertible among themselves at fixed exchange rates, thus acting as a de facto single currency.

Single Effective Exchange Rate: There has to be one exchange rate between the currency of the union and each foreign currency. This necessitates one exchange rate policy for all the member countries which, in turn, needs to have one exchange control authority.

One Monetary Policy: Monetary policy is devised to control: (a) money supply; (b) exchange rates, (c) rates of interest, and (d) inflation rates. One monetary policy for all the member countries is the nucleus of an effective monetary union.

Not all the monetary unions formed in the past withstood the test of the time. Quite a few of them failed. It would be a useful study to look into the causes of their failure before harping on the need of one more such union.

An objective analysis of the operational disciplines of some of the past unions dwells upon the following as the causes of their failures.

(i) Non-existence of a strong partner for administering centralized control on the entire operation, especially during the crisis The example is that of the Colonial New England Union which collapsed when small partners started resisting economic supremacy of Massachusetts, and, in violation of the agreement, over-issued their currencies.

The other side of the picture is equally significant and thought provoking. Strong dominating partnership of Germany, France, and Belgium have been mainly responsible for the success of Zollverein, CFA Franc Zone, and the Belgium-Luxembourg Union respectively. These dominating partners assumed the role of de facto leader, controlling the economic and the monetary policies of their respective regions.

(ii) One common currency without a common monetary policy, or a common monetary policy without a common monetary authority Latin Monetary Union collapsed due to this deficiency. This was also one of the reasons for the disintegration of the East African Currency Area.

(iii) Bimetallic currency standard with the official exchange rate between the two currencies varying from that in the open market Latin Monetary Union ended owing to this exchange disequilibrium.

(iv) Dumping in one or more member states of the debased and the low-valued subsidiary coins, being legal tender across the union Latin Monetary Union and the Scandinavian Monetary Union suffered from this loophole.

(v) Fixed official price of gold in the wake of the depreciated paper currencies issued without adequate gold reserves This led to heavy purchases of gold in cheap currency at the official price, which was below the open market rate. The Scandinavian Monetary Union had the brunt of this 'gold romance' .

Evaluating of the potential of the proposed Islamic Monetary Union (IMU) in the context of the track record of the monetary unions of the past would not be a futile exercise. Let us, therefore examine its viability in the light of the aforesaid.

Strong Dominating Partner: A strong dominating partner is the driving force behind an effective union. Who qualifies to assume this role in the Muslim world? On the contrary, we belong to the lot who can go to the extent of accepting disintegration of the country rather than to accept the upper hand of other countrymen with different political affiliations. We seem to be the believer of the saying that no sheath can accommodate more than one sword but at the cost of the sword and the sheath itself.

This feature had been non-existent in the EMU also. The "bad tempered argument", chiefly between President of France, Chancellor of Germany, and the Prime Minister of Netherlands, over an already settled issue of the presidency of the to-be-established European Central Bank, which overshadowed for 12 hours the 2nd./3rd. May l998 session of the summit at Brussels was tantamount to a sign of distress.

Observers from all over the world concluded that dividing the term of the first president clearly breaches the treaty's spirit. It has, on the one hand, damaged the bank's credibility as an independent entity, and, on the other hand, tarnished the image of Mr. Duisenberg, once the unanimous incumbent of the office of president. They asked the question, "if it takes 12 hours of hard pounding to pick one man for a job, what are the chances of future summits sorting out far bigger and more controversial matters?" The IMU, if established, would come across identical situations and similar questions too often. The salvage of the Union will obviously lie in how these questions are answered.

Road to Political Integration: Another important question that haunts the minds of the well-wishers of the Muslim world is, can a group of countries adopt a single monetary policy and a single currency and yet keep most other areas of policy decentralized? Unfortunately, the apprehension that eventually it is bound to culminate into a political union looks impossible to dispute.

There is also no denying the fact that subscribing to a currency unification move is tantamount to foregoing some sovereignty the sovereignty to regulate the monetary policy in conformity with the prevalent economic conditions. Thus, the advantages associated with a single currency lose much of their charm when weighed against the loss of: (i) independent monetary policy; and (ii) the discretion of changing the exchange rate.

The impact of this loss aggravates manifold if the country or the region is likely to suffer from "asymmetric shocks", e.g. unusual disproportionate economic upheavals, which are not uncommon in our target countries. This poses yet another terrible question. If a country is deprived of the power of regulating its monetary policy or devaluing its currency to combat an economic crisis, what other benefits can compensate it for this loss?

It is owing to these constraints that critics have gone as far as to apprehend "the single currency could lead to a war", or, it could be nothing short of a "political earthquake ".

Optimal Currency Area Theory: The Theory identifies three alternate responses to asymmetric shocks. These are based on the assumptions that: (i) asymmetric shocks are few and far between; (ii) economies of member countries have similar cycles and similar situations; (iii) flexibility of wages is more or less uniform; and (iv) transfer of fiscal resources between member states is smooth and feasible.

Muslim countries hardly meet any of these conditions with the result that any unusual economic shock in any member country would pose a threat to the union. It leads to conclude that the economic conditions of each individual country would be the deciding factor, which also means that the effects of the unified single currency unit (Uscu) on one member country or countries would not necessarily be the same as on another member country or countries.

Interest Rate: Single monetary policy may not be cost-effective, especially if the changes in the rate of interest affect different economies differently. Muslim countries pursuing non-interest-bearing modes of financing have not been able so far to go beyond renaming of 'interest' as 'mark-up'.

Black Money and its Impact on Integrated Monetary System: Black money, whatever its currency, will remain black even after it is converted into Uscu Thus, the conversion itself will not assist money launderers, as the money in its new form also will remain tainted. However, it will take money launderers a step farther down the line to concealment. Criminals who now operate in various IMU member countries will not, after integration, need to convert between those countries' currencies. Consequently, the risks of disclosure on the exchange of large sums of cash will become extinct.

Certain probable member countries of IMU have less stringent exchange control regulations as compared to other probable states in the union. Money launderers who deal in a number of currencies would, therefore, be tempted to shift their activities from the former to the latter. Certain economists have proposed that laws restricting cash transactions between national currencies of member countries and the unified single currency of the union (Uscu, in this case) should be enacted to have an effective check against the black money. However, effectiveness of such laws may be anybody's guess because of the huge quantum of the black money involved.

Forged Currency Notes and Lack of Standard Printing Quality: Until our Uscu becomes widely recognizable, there are chances that forged notes circulate with little restraint. People may not be accustomed to recognizing the security features of the new bank notes. They may not only be agreeing to accept forged notes but may also be inclined to reject legitimate notes as fakes. A wave of distrust and doubt will prevail throughout. With low literacy level in Muslim countries, this problem may be more intensive.

Further, the printing of currency notes undertaken in different countries is exposed to quality-variation risk. Strict and uniform quality control would entail higher cost and complex administrative problems.

Trade Volume and Foreign Debt: It is claimed that with the unified currency the trade between the member countries would increase and dependence on dollar would reduce. This is the same claim that was made at the time of the formation of EMU and introducing of Euro. What has been ignored in this context is the fact that the trade between EMU countries was much more than what it is between the Muslim countries. Take the case of Malaysia itself. Its more than 80% business is from U.S.A. Of the remaining 20%, less than 25% is dispersed among Muslim countries, which too is of volatile nature.

The major share of the foreign trade of the developing countries most Muslim countries fall under this category is from USA. The bulk of the remaining is from Euroland.

Over $800 billion Gulf money is reported to be invested in Western Countries. As far Pakistan is concerned, more than half of her two-way trade is with the USA and the European countries.

Foreign debts are also denominated in US dollars because of which the influence of IMF on national economic, fiscal, and monetary policies of the developing countries is increasing day in, day out.

Financial markets of Muslim world are also operating much below the international standards. To attract foreign capital to these markets in sizeable quantity on terms favourable to them is still a Herculean task.

Level of technological advancement achieved by Muslim countries is not enviable by any standards. Hence, the Muslim countries will remain dependent for their needs for the most of the capital goods and sophisticated services on non-Muslim world.

If the above facts are analyzed, the situation that emerges is not very much in favour of the monetary integration of the Muslim countries, without which to aspire for a unified currency virtually remains a daydream.

Religious Affinity: No monetary measure can subsist in the name of religious affinity alone. Heavy withdrawals from banks in Pakistan on the eve of Zakat deduction should be an eye opener. What we would, therefore, suggest is that religious feelings of believers should not be exploited while talking on issues, such as, "elimination of interest", or, "unification of currency", or, "deduction of Zakat", and so on. Instead, such sophisticated issues should be handled with professional acumen after doing adequate homework.