Steps Leading to the Formation of GCC Central Bank - Case Study Example

The most suitable for the project would be Steps leading to the formation of GCC central Bank. Executive Summary As per the study Gulf Council Countries want to set up a Single central bank operating for all of the six member countries. But the Gulf Council Countries have not yet succeeded to introduce the monetary policy and fiscal policy due to the fact that its economy is largely dependent on OIL which has an impact over the import. The Gulf Council Cooperation is formed with the members from Bahrain, Kuwait, Qatar and the United Arab Emirates. And the members had a common objective of establishing and introducing a single Gulf currency that is to be used by all of its member countries that is Gulf dinar. This will promote easy trade between the member countries, united oil policy will be formulated for all of its member countries, and a single and definite legal framework is to be designed for carrying out its trade and investment, to reduce the parity between the member countries. Establishing a standard tariff or non tariff and imposing it on all of its member countries, providing freedom to the member countries for movement, work, and implementation of economic activities and also freedom in the movement of capital. The power and authority provided to the central bank to carry out its work independently without government interference. Introduction The GCC stands for Gulf Council Countries. The names of the central banks of Gulf Council Countries are Central Bank of Bahrain, Central Bank of Oman, Central Bank of Kuwait, Qatar Central Bank, Saudi Arabian Monetary Agency. The main objective and the responsibility of the central banks in Gulf countries are to foster the balanced growth and development of the Gulf countries. Various theories and rationales have been developed for maintaining the regional integration. These theories include collective external threats, geographic proximity, Political and cultural similarities, joint security which is provided in the instable region. Central bank operates in Gulf countries but one single formulated central bank combining all the gulf countries have not yet been established. GCC monetary policy has been formulated for maintaining stability in the exchange rate, stability in price and growth and minimization in volatility. The structure of central bank for Gulf Council Countries should be based on ownership structure bank specialization, market countries. It should undertake the regulatory compliance, transparency, risk management procedures, transparency and risk taking behavior. The Gulf countries should function in such a way that its regulatory efficiency, bank efficiency and financial performance are enhanced. The very recent financial crisis which was faced by the Gulf countries proved that the regulators, analyst, supervisors and bankers do not have adequate knowledge in finance and banking. The main objective of formation of the Gulf Council countries is to attract and bring foreign investment in the country and make a path to face the financial crisis. The central bank formulated that the operations of central bank will be carried out in accordance with the principles and guidelines formulated by the central bank. Discussion The main objectives for attainment of its goal of central bank are to maintain the credit policy of the central bank in such a manner that it leads to the growth and development of the national economy, provide guidance on the monetary and financial issues, the stability of its currency and the quick convertibility of its currencies in foreign currency. A reserve of gold and foreign exchange is maintained. Central bank has been established separately for each country. But a common central bank operating all Gulf countries have not been established. The main reason that the Gulf countries wants a single central bank for the operation of the GCC as a single entity is they want to establish a common Gulf currency. During 1978 the four gulf countries which included United Arab Emirates, Kuwait, Bahrain and Qatar have together initiated and took an attempt for issuing a common Gulf currency for all the Gulf countries. The selected a single Gulf currency as Gulf Dinar (Lynch, 2010). There are several homogeneous aspects of the Gulf countries. The Gulf countries share same language, history and culture. The single currency option will benefit the Gulf countries by strengthening the position of bargaining power and also it will facilitate easy trade between countries because the same currency is being used for the transaction. The Gulf Council Countries are highly oil dependent countries hence the Gross Domestic product growth is very high. A single monetary Authority will provide benefit to the GCC, as the members of the Gulf Council Countries inherent the same livelihood. The convergence of the Gulf Countries will result in the reduction in the differences between the debt ratio and also the national goals. For a stable monetary union there should be a convergence in the fiscal deficit and debt. The convergence of monetary policies and to establish a single monetary union is very critical. The coordination of the monetary policies of all the gulf countries for establishing a single monetary authority requires collection, analysis and evaluation of all the data and information required for formulating the monetary policy and also the determination and will power of the member countries. Inflation rate affects the monetary policy of the economy severely. Inflation is a situation when the price rises and the value of money falls in an economy which in turn reduces the purchasing power. Price stability can be considered as major element for facilitating the need ad demand for the establishment of new central bank. There is a necessity for the establishment of single and harmonized price indices which will act as a foundation for comparing the price stability between the Gulf Countries Council. It will serve as a base for the establishment of single monetary policy in future (Ishkin and Eakins, 2006). The GCC countries realized the value for stable exchange rate, when they found the importance of US dollar. Most of their transaction was settled in US dollar. The revenue of Gulf council countries mainly comes from its crude oil business. Other petroleum based activities also contribute largely for the development and growth of the gross domestic product. The interest rate of the countries should be calculated, as it is used by the banks. The Gulf Countries Council follows the interest rate of United States. Fiscal deficit is also a crucial issue. As an unstable fiscal deficit in one of the gulf country will force the member union to provide help and assistance to that country with the help of fiscal transfer from its member countries. Members of the Gulf countries decided to undertake the sufficiency in the Exchange Reserve before the single currency for GCC is introduced. The main aim of adopting monetary policy is maintaining the pegged exchange rate system and also the financial stability. The main source of the foreign exchange reserves is the export of oil and natural gas of the gulf countries. The idea and motive of the members of the Gulf countries in establishing a new central bank for the gulf countries is the stability in price of the economy. Government expenditure is considered as an important instrument for economic activities and maintaining the fiscal policy in the gulf countries. The fiscal policies coordination will provide assistance to the Gulf Central Bank in achieving the goal and objective for maintaining stability in the price. According to the Gulf Monetary Union the arrangement of the fixed exchange rate requires the portfolio of international exchange reserves for introducing a single currency. Some of the fiscal issues that require attention of the Gulf countries are such as GCC countries require maintaining their overall tax system, to stabilize the increase in current spending and decrease the unbalance growth of the economy and maintain harmony among the gulf countries, maintaining equilibrium in the revenue of GCC countries (Rutledge, 2008). Stabilization function is considered as one of the important function. Centralized control over the monetary policy is required for receiving the stabilized function. The advantage in maintaining the regional banks together by the central bank is that decentralization of monetary operation can be done more effectively and efficiently than the single central bank performing it fully. The central bank has the power to settle the disputes arising out between the member countries on monetary issues. It has the authority of national representation and can give his final say on the argument. Independence should be provided to the central bank for execution of monetary policy even if it is required to go against the government wish. More independence being provided to the central bank for exercising its fiscal authority the more successfully the central bank will achieve its objective of low inflation in the economy. The inflation rate is generally lower in the countries where more independence is provided to the central bank. Independence provided to the central bank also serves as an opportunity for the central bank in maintaining long run price stability. Similarity and Differences between GCC and European Central Bank The similarity between Gulf council Countries and European Central Bank are that both Gulf council countries and European Central Bank have similar kind of organizational structure. Both GCC and European Central Bank are formed or established to introduce a single currency. Both are related for stabilizing the monetary system. Both of them are focusing on establishing cooperation between the countries. The difference between Gulf Council Countries and European Central Bank are that Gulf Council countries main aim was to provide security for the people of Gulf region. On the contrary the main aim and objective of formation of the European Central Bank is to establish economic union. The food habits, lifestyle and the culture of the people of the gulf countries. Therefore it is easy for them to formulate a single currency. European nation being a large nation the culture, food habits, attitude. Life style of the people varies to a large extent. The central bank sometimes imposes ban on the member countries from public spending and also transfer of payment in lieu of votes. Under such condition central bank plays a vital role in maintaining monetary stability. The process by which the central bank maintains its immunity is by restricting itself from buying much government debt and overextending the credit provided to the government. Independence provided to the central bank will help the central bank in making quick decision (Ocampo, 2007). The cost of a monetary union can be assumed from the fact when a member country enjoys the national currency and also enjoys that it could implement the monetary policy. A national central bank is not allowed to take the decisions regarding the change in the exchange rate alone. The decision regarding alteration of exchange rate has to be taken by the national central banks together with the cooperation of the union wide central bank. Establishment and introduction of a single and common currency leads to the decrease in the transaction cost. More is the bilateral trade among the GCC members the more is the more will be the cost saving from the monetary union. The GCC countries generally follow liberal trade among its member countries. The GCC countries mainly conduct trade outside because they are concerned with production of competitive goods rather than that of complementary products. For the establishment of the single currency, two main issues needed to be highlighted that is the introduction of new currency and its conversion and its introduction in the economy as legal tender money. Conversion rate acts as a foundation for conversion of all money and cash related issues and also exchanging the old bank notes with that of the new bank note. Some of the methods that can be adopted for conversion of existing currency into a new currency are: to consider the valuation of US dollar and assume it as a base and set a new conversion rate which will be equal to that of the prevalent exchange rate of the US dollar. The six currencies are divided into two groups broadly based on the present exchange rate denominated by the US dollar (Low &  Salazar, 2011). The GCC countries can speedily introduce the currency by together announcing and declaring a single currency that will operate in all the six countries and withdrawing the old currency and establishing the new currency. It will establish the exchange rate with full credibility by explaining the authority’s full responsibility towards introduction of the single currency. The GCC countries can also introduce the single currency gradually where it will provide option to use both old and new currency over a longer period of time. It involves the cost of establishing new ATM that will disperse both new and old currencies. Hence it will enable to switch to the single new currency that would be indefinitely deferred. Conclusion The introduction of single currency will help the member countries to carry out the transaction among the member countries efficiently. And the establishment of the single National Central bank for all the countries will help the bank to adopt the single fiscal measure that will be applicable to all of its member countries and the independence that is provided to the central bank will help the central bank to formulate the monetary policy. The Gulf Monetary Union should be set up. The Gulf Monetary Union will have a positive impact on the economy and will provide long term benefit. And the mutual benefits among the member countries will be developed gradually with the introduction of single currency and a consolidated National Central Bank for the members of Gulf Council Countries. A unifying monetary policy will help in introduction of standardized monetary policy. Coordination and cooperation among the members of the GCC is also required. And the effective supervision and formulation of fiscal policy is an important element for the flourishment of the Gulf monetary union to establish and introduce a single strong currency for the Gulf Council Countries. Devaluation is to be avoided as it creates obstacles towards attainment of convergence of currency. Devaluation can be avoided by selecting an exchange rate or choosing the value of US dollar as a reference. Revaluation will lead to the increase in the real value of its public debts and also it will lead in the reduction of price of traded and non traded goods. Gulf council countries dependence on import is highly affected by the inflation rate prevailing in the economy. References Ishkin, F. S. and Eakins, S. G. (2006). Financial institutions and markets. Boston: Pearson Addison Wesley. Low, L. and  Salazar, L. C. (2011). The gulf cooperation council: A rising power and lessons for Asean. Singapore: Institute of Southeast Asian Studies. Lynch, D. A. (2010). Trade and globalization: An introduction to regional trade agreements. USA: Rowman & Littlefield Publishers. Ocampo, J. A. (2007). Regional financial cooperation. Latin America: Brookings Institution Press. Rutledge, E. (2008). Monetary union in the Gulf: Prospects for a single currency in the Arabian Peninsula. Canada: Routledge. Read More