Common Currency

• Author: Ugo Fasano and Zubair Iqbal
• Position: Deputy Division Chief in the Department/Assistant Director of the IMF's Middle Eastern Department

GCC countries face fundamental choices as they head for monetary union.

Regional integration efforts among the member countries of the Cooperation Council of the Arab States of the Gulf (GCC-Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates) have recently gained momentum. During a summit meeting at the end of 2001, the heads of the GCC countries decided to establish by January 1, 2010, a monetary union with a single currency pegged to the U.S. dollar. Under the proposed strategy, member countries have decided to officially peg their currencies to the U.S. dollar by the end of 2002, and adopt economic performance criteria by no later than 2005 for the policy convergence needed to support the monetary union.

Since the GCC was created in the early 1980s, its members have taken significant steps toward economic integration, including the convergence of rules governing the mobility of capital and labor and plans for a single common external tariff by January 2003. The establishment of an economic and monetary union will create an important regional entity that in 2001 had an estimated combined GDP of about $335 billion, average weighted per capita income in nominal terms of $12,708, and 45 and 17 percent, respectively, of the world's oil and natural gas reserves (see table below).

[ SEE THE GRAPHIC AT THE ATTACHED RTF ]

Coming challenges

The GCC countries face dual challenges in the period ahead: reducing vulnerability to oil price fluctuations and accelerating non-oil growth to generate employment opportunities for the rapidly growing domestic labor force. These challenges have to be addressed while ensuring intergenerational economic equity from the exploitation of nonrenewable natural resources-oil and gas. Despite diversification efforts, the oil sector still contributes on average about one-third of GDP and accounts for three-fourths of annual government revenue and export receipts, making the GCC countries vulnerable to oil price fluctuations. In addition, growth of non-oil GDP has been slow in some of these countries, while strains in the employment market for nationals have emerged, with the GCC labor markets remaining segmented between nationals and expatriates. The GCC governments are aware that responses to these challenges call for sustained structural reforms aimed at optimizing market-based resource allocation and private sector-led growth. In fact, GCC countries are currently at various stages of implementing structural and institutional reforms, including lifting impediments to foreign direct investment, streamlining business regulations, expanding private investment opportunities in key sectors, and improving corporate governance.

The planned monetary union of the GCC countries will reinforce the beneficial effects of these reforms and sound macroeconomic policies and help them address the two main challenges. The monetary union is likely to promote policy coordination, reduce transaction costs, and increase price transparency, resulting in a more stable environment for business and facilitating investment decisions. However, although direct gains (such as increased intraregional trade) from the union might be relatively small for these countries, indirect gains could be more important. In particular, the introduction of a common currency is likely to enhance growth prospects by contributing to the unification and development of the region's bond and equity markets and by improving the efficiency of financial services. In contrast, the costs of monetary union to individual countries-such as giving up the ability to set an independent monetary policy...