Central Banking in Gulf Countries - Assignment Example

Central Banking in GCC Executive summary The unity of the Gulf countries has so far aided the countries in theirtrade through the opening up of borders and setting similar tariffs for external trade with non- member countries. This advantage is anticipated to increase with the introduction of a common central bank for the region as well as a common currency. The two will see the formulation of financial policies in the region that will help deal with the issue of inflation and interest rates. This is bound to give the oil rich region more control over their economy and balance trade within and beyond their borders. Introduction Central Bank is an institution mandated with controlling the supply of currency within a given economy; either a country or a block of countries. The institution uses various tools at its disposal to control the currency supply including the open market operations, discount window lending and change in reserve requirement (Grossman, 2010). The early central banks in the world included the Swedish Riksbank and the Bank of England traced back to the 1668 and 1694 respectively. The two institutions were mandated with managing governments’ debts and also held deposits from other banks. This was later developed to have them manage the money supply of the various countries where they operated. The European central bank was an aftermath of the adoption of a single currency system of the European Union. The countries signed a treaty to have a common currency for the member states, the Euro. With the acceptance of the Euro as a common currency, there was need to stabilize the economies of the member states thus the move by the central banks within each of the member states to form a unified central bank for the region. Though having a common ECB, the individual countries still have their own national central banks due to varying internal conditions of the various countries. The European community that adopted the use of the euro is represented by the international organizations and other forums where the European matters are of concern. Though a public authority, the ECB operates similar to a corporation in its management and operation (Scheller, 2006). The GCC countries also have decided to form a similar organization of the countries in the Galf Arab states. The Gulf corporation council comprises of six member states; Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and United Arab Emirates, The countries are united by the common factor of the situated along the Persian gulf and they share a common language. Furthermore, the countries are all Arab and Islamic states thus can develop similar economic and social union with a lot of ease. The dependence of similar economic factors is another reason for the formation of the bank; these countries are majorly oil and gas exporters, thus have a common economic activity that necessitates economic convergence. Proposed structure of the central bank for GCC The expected GCC central bank will serve the interest of the Arab member states. With the Muslim majority of the GCC countries, some aspects of the sharia law will be reflected in the central bank system. The system does not support the use of interest rates, thus the currency of these countries is pegged on other currencies with majority of them pegging their currency on the US Dollar. This has seen the currency of these countries being relatively stable due to pegging on a stable currency, thus pegging the common regional currency on the US Dollar will facilitate stability of the exchange rates of the currency. With economic similarity, the GCC is expected to have smooth economic convergence since their economies are mostly dependent on the export of oil and gas (Sturm & Siegfried, 2005). Therefore the process of forming a common currency will be simpler; similar economies will require little exchange rate adjustment of the various currencies currently used to the common regional currency. The GCC central bank should offer financial assistance to member states in times of the financial crisis though pulling of resources together from the member countries to enable the bank have enough reserve (Faure 2013). The reserve amount will be a security to the Gulf nations in case of a financial crisis. Therefore the central bank will be more of an insurance cover for its member states against a major economic downturn. With the common central bank, price stability in the region is expected to prevail. The bank is mandated to ensure stable prices in the region, especially since the region is mostly an oil export region thus stabilizing prices is necessary. With the stable prices comes the reflection of economic well being of the nations through growth (Faure, 2013). Moreover, the central bank will exist side by side with the national banks of the various countries, so that the national bank is still responsible for the internal country affairs since it is already used to handling the affairs of the country while the central bank will be in charge of the whole region so that there is a need for cooperation between the two. Independence by the central bank will be adopted to ensure the bank operates in a free environment without undue influence. With this it will be able to formulate and implement monetary policy across the region without any political interference, especially during elections where politicians are known to increase money supply giving a false impression of an economic boom resulting into inflation. The implementation of the central banking system will also differ from others done before in that the formation of the central bank will come before the adoption of a common currency thus complicating the execution of the institution’s mandates. Comparison with European central bank Unlike the European central bank, the GCC central bank will serve oil exporting countries, thus the aspect of price stability will be especially necessary for exports to ensure the GCC get the maximum possible income from their exports. Having similar economies will contribute greatly to the economic convergence thus the monetary union, but may lack fiscal union unlike the European Union which has both monetary and fiscal union. Furthermore, the European central bank is not influenced or based on any religion, but is founded on the secular law and financial policies governing the European nation unlike the Gulf central bank, which is based on the Muslim religion given that the Arab countries are governed through Muslim leadership. With this comes the issue of interest rates, thus the GCC currency will have to be pegged to another currency for interest rates to be implemented. For the European Union, the euro is not pegged on any other currency but exists independently and is traded fairly in the foreign exchange market. Formation of the central bank in the GCC is also different with the formation of the European central bank in that the European central bank was formed after the adoption of the common currency while there are high chances of the GCC central bank being formed before the adoption of a common currency. The disagreement on the use of a common currency may affect the operation of the institution being formed. This is because the countries are being cautious of the effects on their economy the central bank and the common currency will have. However, the two central banks will also have a similarity. Both have the authority of serving independently as a central bank without undue influence. This is especially due to the politics of the countries which have a practice of increasing money supply during the election for campaign purposes leading to excess money in circulation thus inflation. With the central bank, the financial policy formed will be aimed at curbing inflation, thus no excess pumping of money into the economy will occur. The two central banks are also involved with helping any members’ state in case of a financial crisis thus serve as an insurance policy against financial crisis. With the reserve requirement, the central bank will be able to caution the economy against losses associated with the depression of the economy which may lead to the fall of various giant banking institutions in a country. The central banks also unite countries with common interest and share the same geographical area thus facing similar conditions. This is vital for the facilitation of accurate functioning of the central bank due to the economic convergence thus the similar interest of the country’s leading to unity of the region in formulating financial policies. Furthermore, the regions had already formed a block that is the EUC and the GCC before the formation of the central bank. These communities are especially for trade purposes with unlimited trade already existent in the GCC members while the block already has common tariffs for trade with other non-member countries. Also the dominance of the GCC financial sector by small institutions differ from the EU but the GCC records higher profit than the EU in its financial sector (Ayadi and Groen, 2013). Arguments on the GCC central bank With the formation of the GCC central bank comes both positive and negative effects both to the country and the world at large. The formation of the GCC will see the stabilization of the Arabian economy through having a common central bank to sever the interest of the countries. With a common central bank, the countries’ economies are bound to improve due to a higher bargaining power as a block. The central bank will represent the interest of the states in financial forums where the contribution of the states is required. With this, the countries will have a solid stand through their central bank which serves their interest collectively in financial policy matters. With the unity of the Arab countries comes peace in the gulf region. This peace is necessary for the stability of the people in the region and global coexistence due to the regions role of supplying oil to the rest of the world. Moreover, the central bank will be able to stabilize prices in the region through financial tools used to control inflation (International Monetary Fund 2012). With stable prices the people will not be strained by the unexpected inflation in the region. Furthermore, there will be no feeling of insecurity in the region as no country will be viewed as a threat to another due to a fair playing ground financially and economic similarity. The stability will see the reduction of the government spending on recurrent expenditure and concentrate more in development projects like creating infrastructure. With the expected monetary union, transaction and accounting cost will be eliminated (Khan, 2009). These costs are mostly associated with exchange rates of the various countries thus the use of a common currency will see the elimination of these costs in this region leading to efficiency in the market. With the labor force in this region mostly coming from outside, the formation of a central bank and use of common currency will enable the region to employ more labor from within the region. This will lead to the wellness of the citizens residing in these countries due to increased jobs for them instead of importing labor from other nations. With the independence of the central bank, it will be able to achieve a monetary policy mandate of controlling inflation and exchange rates (Aizenman and Glick, 2014). With the However, the socio-political factors have delayed the process of monetary union in the region. The lack of common business circle between the GCC countries is a factor against the formation of the unitary common currency (AlKholifey & Alreshan, 2014). This is further detered by the lack of long term relationship of GDP of the countries on top of the lacking symmetry of the supply and demand shock. Most important objectives and functions of the GCC bank The economic stability of the region is one of the major objectives of the region. This is through the stability of prices thus dealing with inflation in the region. According to the GCC charter, the main objective of the GCC is to have integration, coordination and interconnection among member states (GCC, 1981). The charter therefore forms a basis for the formation of the GCC central bank. With regional integration, the central bank is expected to foster the circulation of the common currency to be introduced to enable ease of trade among the member states. The bank will also be mandated with formulating financial policies that serve the interest of the region. With the central bank and a common currency, the bank will be mandated with maintaining a stable interest rate for the common currency. Through the integration, the cost of transaction and conversion to other currencies will be eliminated thus reducing cost of trade in the region. With the opening up of the border to free trade in the GCC, there is need for a regulatory body to control trade through various monetary policies to ensure fair trading practices that do not hurt the economy. With a common central bank, the region’s currency will appreciate in comparison with other currencies with the management of the central bank. Furthermore, reserves to be held by the GCC central bank will serve the member states to help them in times of financial crisis. Conclusion With the introduction of the central bank in various other regions successfully, the GCC central bank is a good opportunity to develop the region financially. This will uplift the status of the Gulf region globally due to the unity in fostering economic well being. This will further help the region deal well with the inflation experienced in the world as the bank will be better suited to deal with the inflation experienced across the Gulf region and not in a single country. Introduction of the single currency to the region will also aid in trade in the region with internal trade being made easier among member states while the external trade is based on a common currency thus no country feels left out in the trade. With the countries depending majorly on oil and gas, the Central bank will help cushion them against extreme price changes for these commodities worldwide. Referrences Aizenman, J. & Glick, R., (2014). Asset class diversification and delegation of responsibilities between a central bank and sovereign wealth fund. International journal of central banking, Vol. 10, No. 3, September 2014. AlKholifey, A., & Alreshan, A. (2014). GCC monetary union. Bank of international settlement. Ayaka, R., & Groen, W. P. (2013). Banking and insurance in GCC countries: is there regulatory convergence with the EU? Shakara research papers. Faure, A. P. (2013). Central banking and monetary policies: an introduction. Quoin institute (Pty) limited. Grossman, R. S. (2010). Unsettled account: The evolution of banking in the industrialized world since 1800. Princeton: Princeton University Press. Gulf corporation council (1981). Background and objectives. Indian ministry of external affairs. International monetary fund (2012). Economic prospects and policy challenges for GCC countries. Khan, M. (2009). The GCC monetary union: choice of exchange rate. Washington,Massachusetts avenue, Peterson institute of international economics. Scheller, H. K., (2006).The European central bank: history roles and functions. Germany, frunkfurt am Main, European central bank. Sturm, M., & Siegfried, N. (2005). Regional monetary intergration in the member state of Gulf cooporation council. European central bank, occasional paper series no. 31/ june 2005. Read More