MONETARY UNIONS: PROSPERITY IN ECONOMIC GROWTH

QAZI WAQAS AHMED (qwavicky@yahoo.com)
May 25 - 31, 2009

By the end of 2010, the six members of Gulf Cooperation Council are planned to launch a Single Currency for deepening economic integration.

The smooth launch of the euro has nudged other nations to consider forming monetary blocs. The Association of South East Asian Nations, New Zealand and Australia, and the Latin American countries are debating the advantages of economic integration.

The need to create a zone of monetary stability in the sub-region has long been recognized as a necessary step to boost intra-regional trade, catalyze foreign investment, and stimulate economic growth. Regional economic integration involves an agreement among neighboring nations to allow for the free flow of ideas, investment funds, technology, goods and services, and free movement of persons within the region in which a single large market subsists with the benefits of comparative advantage and economies of scale. Regional economic cooperation has gained momentum partly as a strategy to cope with global economic problems and partly to enhance domestic economic growth and development.

Forming a Monetary Union or a building block for single currency is not only beneficial in terms of bi-lateral trade between the member countries but also for gaining international favors in terms of trade and economic benefits. Free capital movements permit the markets, to direct the economic resources into their optimal uses. For example, the common market in Europe provides free movements of capital. In real terms, it is more difficult for a country to achieve trade agreements with wealthy international nations but easier for a block or member states to negotiate for Free Trade Agreements. For example, Free trade agreement (FTA) negotiations between Australia and the Gulf Cooperation Council commenced on 30 July 2007 and both parties are benefitting from increase in trade volumes and broad line of bi-lateral trade options.

Economic integration is a long-term mission and takes up few decades to reach at implementation stage. The group of participant countries has to set out broad lines for the coordination, integration, and cooperation in various aspects of economic affairs. They have to take steps toward realizing the different stages of a full economic integration namely, a free trade area, a customs union, a common market and economic union.

The best approach is management of economic areas through separate committees and then to combine them for a final implementation of the new monetary union which leads towards a new currency.

COST AND BENEFITS OF A MONETARY UNION

It is vital for a group of nations willing to make a currency union to examine if there is need for a single currency. Optimum Currency Area (OCA) is the main theory or basic framework to analyse the need of a single currency. The concept of optimum currency area is applied where a region has possible chances for its own single currency and a single monetary policy for all the states or member nations. Hence, the optimum currency area can also be termed as the Currency Union or Monetary Union.

The structure of an OCA comprises of monetary integration, a single currency and a common central bank. This helps control the flow of foreign exchange reserve and administrate the policies for the member states. Monetary integration involves the irrevocable fixing of the exchange rates, full and complete convertibility of currencies, financial market integration (measures to liberalize capital transactions and harmonize national financial regulations and structures of institutions), the complete liberalization of current transactions and a common monetary policy.

The criteria for optimum currency area are based on how integrated countries of the potential group are with one another in terms of trade and other economic relationships. It also covers the extent of correlation in their business cycles and similarity of economic shocks they are subject to in different conditions. A further advantage of an OCA is that it may reinforce discipline and unified monetary policy, which benefits countries with high inflation. The credibility of monetary policy can be enhanced by attaching the latter to a low-inflation currency. This was the case of the high inflation European countries of Italy, Spain, and Portugal in the 1970's that wanted to tie their respective exchange rate to that of Germany for its credibility for fighting inflation.

Monetary integration is the second need for a single currency as in case of European Monetary Union and Gulf Monetary Union. The formation of European monetary union was a base step to the Euro single currency. The main theme behind the single currency and the monetary integration in case of the Euro was the locking of irrevocably exchange rate to provide single mechanism (cross border terms and policies) of trade across the Euro member countries.

This can also be seen in the case of Gulf Cooperation Council and the emergence of a single currency for this region. Considering the process of Euro as a benchmark the GCC is also on the same path to monetary integration. The strongest economic argument against monetary union is the obvious diversity of the economies involved. Problems will emerge when economies with different fundamental economic structures, levels of efficiency, productivity, and inflation are integrated under a single currency. If all economies are the same and have similar objectives they would possibly adopt the same policies and respond in the same way to changing circumstances, thus eliminating many of the advantages of fixed exchange rates. The main rationale behind fixing exchange rates is that economies are not all the same and it is necessary to constrain national monetary authorities from short-term political aims for the sake of overall efficiency gain.

After the successful launch of European Monetary Union, the world is expecting a new single currency from the Gulf States. The Middle East region can, in several respects, claim a number of advantages over other areas. It has substantial financial assets, a strong resource base, more than 300 million people who share a common tradition, a history of entrepreneurship that goes back thousands of years, and a strategic location between the East and West.

On May 25, 1981, the countries of the Arab Gulf region, Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates agreed on the charter establishing the Gulf Cooperation Council (GCC). All the GCC member states are members of the Arab League and Qatar, Saudi Arabia, Kuwait and the United Arab Emirates are the prominent members of OPEC. These six states realized the need to establish a regional common market to improve their trading position and economic benefits and since the formation of the GCC the six member states have been edging towards a common Gulf currency.