The Structure of the Suggested Central Bank for GCC - Assignment Example

The structure of the suggested Central Bank for GCC Introduction This paper tries to expand on possibilities of forming Central Bank for GCC and the expected gains and costs alongside losses. This is discussed beyond the boundaries as defined by economic theory but explained alongside structural changes within global economy. From previous researches the economies of the GCC countries is revealed as unique since they share several homogeneous characteristics. This is as a result of several factors such as their language, similarity in culture and history that makes the countries face similar economic challenges which necessitates possibilities of stronger economic integration. Additionally, the Gulf States generate wealth from their vast oil and gas resources that allows their economies to operate above unprecedented development. The empirical research in this study provides information that supports creation of a well-developed financial system. One of the issues captured in this report tends to answer the question on the better options that are required for economic growth within different regions. The GCC region supports bank-oriented financial system that is contrary to market-oriented financial systems supported by the United States and United Kingdom. According to Demirguc-Kunt and Ross (1999), the structure of financial system and overall level of development is crucial for establishment of suggested Central Bank for GCC. However, financial development majorly depends on legal and political institutions. Based on Structure-Conduct-Performance (SCP) model, the study explores implication of structure and conduct on overall performance of suggested GCC financial institution. According to theory of Industrial Organization, structure refers to the extent of concentration of market shares within the market while conduct refers to general behavior of firms measured by efficiency and profitability (Demirguc-Kunt and Ross, 1999). The structure of the suggested Central Bank for GCC The banking sector is considered one of the major conduit for economic activities within GCC region. Growth of GCC countries is dependent on critical valuation of the structure, conduct as well as performance of banking industry. Monetary union presents an important cornerstone of an economic union based on chosen political power. The structure of the GCC central bank should be based on sound technical basis and at the same time considered a strategic goal (Strum and Siegfried, 2005). A realistic step towards such a goal involves formation of monetary union that ultimately realigns different political systems. In the European case, monetary union was used as a stepping stone towards further strategic objective, which is political unity. However, The Gulf Monetary Union should consider reviewing current coordination framework that exists between fiscal policies of individual members for the purposes of enhancing development of regional financial sector (Ergungor, 2003). The creation of the central bank requires development of possible structures capable of coordinating all fiscal policies as well as the unified monetary policy across Gulf currency region. The structure should allow for high consultation, coordination alongside agreement between financial bodies of member states. Such agreements should entail information on budgets in the medium term. Further, binding mechanisms such as transparency, commitment and control are crucial since they ensure monetary discipline (Ergungor, 2003). Extensive and efficient coordination between unified monetary policy and fiscal policies is important in various sectors for the purposes of harmony. Such coordination is required in matters concerning domestic public debt policy and its effects on economic cycle, the nature of inclination towards public borrowing and the season of government spending. The structure should incorporate services of supra-national economic council comprising of finance ministers, board of director and governor of the GCC central bank. The purpose of the council in providing financial planning services based on local borrowing, spending, income from proceeds of exports and foreign investments (Ergungor, 2003). Differences and similarities between GCC Central Bank and the European Central Bank Monetary and fiscal convergence in GCC is seen a remarkable example of monetary convergence since it is characterized by low inflation rates and short-term interest rates. The high degree of stability of intra-GCC exchange rates is associated with their currencies long-standing cooperation with the US dollar. However, European Central Bank (ECB) was established as a result of European Union economic and monetary integration. The EU integration was considered more advanced hence becoming an example for other regions of the world. Successful introduction of the euro resulted into several debates concerning regional monetary integration as well as formation of different currency blocs. On the other hand, plans involving monetary integration within GCC states dates back to Unified Economic Agreement ratified in 1982. However, the planned GCC monetary union seems to be one of the most advanced initiatives towards achieving monetary integration in the Arab world (Arab News, 2008). One of the similarities between the two central banks rests on the idea of integration. However, the GCC central bank is expected to face very different challenges from those of ECB associated with Euro crisis. Creation of central bank in both cases results into member states complying with the policies of a common Central Bank; individual states no longer apply different monetary policies. Moreover, both central banks operate on standardization process aimed at achieving closeness amongst different policies from individual states. These policies touch on inflation rate, interest rate, foreign exchange rates, public as well as annual budgetary deficits. However, in the European Union, the countries are weighed down by budgetary deficits and the magnitude of public debt since the governments fund their spending from borrowed money (Almonitor, 2013). Any form of borrowing from European Central Bank is governed by Maastricht and Lisbon treaties. The treaties forbade borrowing from ECB by individual states, therefore, focusing on the limits of annual fiscal deficit and public debt of each country in relation to their gross domestic product (GDP). The ECB influences the economies of member states through balancing of payments from governmental spending. However, in such a case, there is possibility of great effects from spending financed by borrowing. Such effects on monetary supply and balance of payments determine the stability of euro exchange rate. Conversely, GCC governments do not depend on borrowing to finance spending since the countries are rich in oil and gas resources including massive monetary reserves. The GCC Central Bank, therefore, does not require setting standards or limits that governs borrowing alongside forbidding member states borrowing from central bank. Heavy reliance on oil and gas exports provides enough governmental revenue. In the case of GCC central bank, fiscal policy is more considered as the main determinant of monetary supply. On the other hand, monetary policy is considered as major control on monetary developments that results from increased government spending. The policies are regulated by external factors based on global prices and the demand on oil and gas globally (Almonitor, 2013). Within the GCC region, government spending is always directly influenced by the existing state in the balance of payments including trade balance. Such influences ultimately affect government spending as well as monetary supply. The central bank in this case contains monetary supply for the purposes of preventing inflation by increasing interest rates. However, in case the member states reach a point where they spend their oil resources within the region, there is possibility of individual countries applying different interest rates. This will lead to central bank developing interest in public spending of each member state. The nature of economic development in the GCC’s was as a result of soaring oil prices in the 1970’s and early 1980’s. The period ensured big returns from government revenue as well as extra revenue generated from external current accounts. This was the start on the expansion of infrastructural development including oil and gas production base. Such level of liberalization on the economy of member states resulted into growth of financial services as well as non-oil related economic activities. However, the diminution of the oil prices from mid 1980’s led towards significant deterioration of the economy resulting into financial imbalances. This was one of the cases that led governments to employ alternative plans that involved considering their spending. The effort was reinforced by the central banks role in cutting down revenue imbalances and promoting growth within informal sector (Gray and Blejer, 2007). According to economic theory for establishing an optimum currency area (OCA), there are a number of conditions that requires attention by involved parties. However, availability of such conditions is considered relatively higher in some regions like GCC compared to European Union countries. Such conditions for Optimum Currency Area include economic openness, mobility of factors of production, degree of economic diversification, various shocks in production structures, existing consistency of fiscal policies as well as political will. However, currency represents one of the most important factors symbolizing national sovereignty. Political will is also one of the determining factors since it influences the success and continuity of monetary union project (Buiter, 2007). For instance, the case of European Union presented issues on political persistence that ensures formation of a monetary union in spite of existing difficulties and problems that are either economically or politically motivated. One important lesson from European case is the need for high level flexibility within political field, waiver of some sovereign issues in relation to financial and public debt policies. Development of economic policy requires that independent states abandon their national currency which is a symbol of national sovereignty. The arguments for and against the GCC central bank There is a possibility that a single currency may have negative impact on some GCC countries as was the case with European Union. In EU case, Germany was negatively affected by French economy and also Greece’s debt crisis led to adverse effects on European member states. Such cases are equated to macroeconomics imbalances that usually spread amongst union members. Failure to adhere to standards of economic integration and financial regulations set by member states could lead to instability of the single currency and ultimately damage economic relations. This is since the central bank assumes the position of one monetary market in cases of crisis. However, future developments within the global economic world could influence the cost of formation of GCC Central Bank (Strum and Siegfried, 2005). There are positive arguments towards the adoption of a more flexible exchange rate policy in case of monetary union. The monetary policy resulting to formation of Central Bank can be used as a stabilization tool in the event that the current currency is pegged to the U.S. dollar. This gives the region the benefits of reducing volatility in exchange rate as well as capital flows that could otherwise expose the region to nominal shocks. The central bank would also ensure adequate provision of credible support to existing monetary policy. The bank would also ensure simplification of trade, financial transactions as well as accounting processes within the GCC region. Flexibility in exchange rates usually allows countries the possibility of adjusting to real shocks in a better way as compared to fixed exchange rate regimes (Buiter, 2007). There are arguments for and against establishment of GCC Central Bank that will serve member states of the Gulf Cooperation Council (UAE, Bahrain, Saudi Arabia, the Sultanate of Oman, Qatar and Kuwait). There are several factors underlying the process that are of technical economic and political origin. The integration faces an economic challenge for GCC monetary union, owing to the lack of economic integration amongst the GCC member states. Formation of Central Bank may affect individual nation’s currency strengths that determine free movement of goods, services, capital and persons among the GCC member states. The case concerning use of single currency will pose challenge to most members due to their small size apart from Saudi Arabia as well as high level of openness (Strum and Siegfried, 2005). However, creation of GCC central bank would also enable creation of some significant advantages to member states that are of economic and security benefits. From economic perspective there would be creation of an effective common market for goods, services including capital and labour. From the political perspective, the central bank would encounter difficulties due to the absence of effective supranational political institutions that are common to the six GCC member states. This is since there will be absence of an institution that would ensure effective political accountability of the GCC central bank (Buiter, 2007). The countries forming GCC finds it difficult to surrender their political sovereignty for the purposes of joining a monetary union. This is due to the increasing level of sophistication within political citizenry (Buiter, 2007). The Central Bank will have to face differences of inflation rates from GCC countries. Such difference in inflation rates is due to the difference in the size of oil resources that determines government spending. There is also unjustified relation between interest rates in the GCC countries and European Union. The global financial crisis is considered as one of the major hindrances that affected regional integration. Despite the crisis, GCC monetary union was geared towards lowering costs associated with foreign exchange rate and increasing transparency in pricing of goods and services and also enabling transparency in competition and trade. However, the crisis unveiled potential weaknesses that existed within the GCC financial sector, which were later solved with unclear treatment procedures. The applied procedures slowed down further development of structures safeguarding financial products. Increase in risk aversion procedures and revision of lending practices took place after crisis associated with Dubai World debt problem and financial problems in Kuwait. Important objectives and functions for GCC central Bank The GCC member states focus on several primary objectives of establishing the central bank. The Monetary Council focuses on important infrastructures necessary for establishing regional unity. The major reason is the enhancement of cooperation amongst National Central Banks for the purposes of providing required conditions for Monetary Union (Strum and Siegfried, 2005). The central bank shall be mandated to benefit from independent legal personality within limits of duties set in GCC statute. The bank shall have the primary objective of ensuring stability of prices in the region through optimal utilization of available economic resources. Moreover, the central bank shall define and implement the use of single currency including exchange rate policy ensuring compatibility within the region through National Central Banks. It also serves the task of managing foreign cash reserves of the agreed upon single currency. Issuance of banknotes as well as coins in the denominated single currency remains the task of the GCC central bank. This includes ensuring efficient operation of the infrastructure that necessitates payment and settlement systems within GCC region. All operation tasks that involve statistical and advisory functions are considered the responsibility of the Central Bank including development of rules for supervising financial institutions (Strum and Siegfried, 2005). The GCC Central Bank has the responsibility of representing single currency area within international organizations and forums in terms of monetary and financial incentives. This is made possible especially in cases dealing with monetary and exchange rate policy matters including agreements on international, bilateral or multilateral platforms. In the process of adopting economic policies for the purposes of achieving macroeconomic convergence, the member states shall look unto the Central Bank for direction on procedures and mechanisms necessary for ensuring adequate monitoring and assessments. The CB will perform these tasks with the help of National Banks within the stipulated timeframe (Strum and Siegfried, 2005). Conclusion GCC member states are characterized by different legal systems as well as different regulators with two-tier regulatory system having free zones. These countries propagate their individual economic agendas that focus on diversification and encouraging country investments. Such perception automatically leads to natural competition between member states since they want to promote individual regulatory models. At the same time, these countries are at different stages of development, and the removal of formal barriers to free movement of goods and services as well as capital flows influenced integration process. The use of interest rate and equity prices within the structure of financial system determines the extent of monetary integration amongst member states. However, there are some factors that are potential hindrances towards regional and global integrations. These are elaborately discussed in this study and include variations in regulatory standards set by regimes and extent to which regimes are open to foreign participation. Subsequently, such hindrances can be eliminated through incorporation of best financial practices and corporate governance through a well structured central bank. Globally movable inputs that include capital flows and natural resources determine the extent of economic development within the GCC region. From this study, there is general perception that the unique attributes of GCC member states influences their monetary and fiscal policies. This is since the member state policies favor free movement of people, goods and services across their borders. GCC countries largely export natural resources and capital while maintaining their profile as key importers of merchandise (Gray and Blejer, 2007). However, GCC member states are known to be predominantly oil and gas driven economies since their government expenditure are all influenced by the gas and oil resources. From economic perspective, major developments within GCC nations depended largely on their trade with the central bank. However, even balance between available resources and existing political limitations presents minimal prospects in trade between member states. Moreover, the relations between GCC countries and countries from the MENA block achieved a greater economic incorporation especially through human capital. The features and factors presented above on structure, operations and objectives of the GCC central bank adds to the present scenario in the efficiency within the banking sector. Also the sustained growth within the non-oil sector is largely attributed to the regular occurrences of instability within of oil market. In my view, efficient financial planning used alongside proficient deliberations have necessitated a review of political and economical strategies within the region. Such assurance has ensured existence of trust, general growth of the economy and countries venturing into other productions that favor the services industry. The relationship between economic development and job creation has declined over the years owing to the extent of effectiveness achieved. The level of industrial growth necessitated by technological improvements has ensured reliability within the banking sector. However, free flow of human capital has been least affected by various changes in economic policies. Due to the GCC’s liberal economies, there is clear indication that capital and natural resources are significantly influenced by the trade policies within the global market (Gray and Blejer, 2007). References Almonitor. (2013). GCC States Learn Lessons from the Eurozone Crisis. Retrieved from http://www.al-monitor.com/ Arab News. (2008). GCC Common Market Becomes a Reality. Retrieved from http://www.gulfbase.com/ Buiter, W. H. (2007). Economic, political, and institutional prerequisites for monetary union\among the members of the Gulf Cooperation Council. In: Preparing for GCC Currency Union: Institutional Framework, 20-21 Nov, 2007, Dubai, UAE. Demirguc-Kunt, A., & Ross, L. (1999). Bank-based and Market-based Financial Systems – Cross-country Comparisons. Volume 1.  Policy, Research working paper no. WPS 2143, retrieved from http://go.worldbank.org/QEPFY6TRA Ergungor, O.E. (2003). Financial System Structure and Economic Development: Structure Matters.  Working Paper 0305, Federal Reserve Bank of Cleveland Gray, S & Blejer, M I. (2007).The Gulf Cooperation Council Region: Financial Market Development, Competitiveness, and Economic Growth’, in Drzeniek Hanouz M. Sh. El Diwany, and T. Yousef (eds.), The Arab World Competitiveness Report 2007 – Sustaining the Growth Momentum. Geneva: World Economic Forum. Retrieved from http://www.weforum.org/pdf/Global_Competitiveness_Reports/ Strum, M., & Siegfried, N. (2005). Regional monetary integration in the member states of the Gulf Cooperation Council. Occassional Paper Series No 31, Frankfurt, European Central Bank June Read More