Gulf Cooperation Council

Question: Discuss about theGulf Cooperation Council. Answer: Exchange Rates It is worth pointing out that in the last two decades the GCC have realized considerable economic and financial integration. Most barriers to free exchange of goods and movement of labor have been eliminated. Additionally, the member countries exhibit to a significant degree political and economic homogeneity (Gulf News, 2013). Also, nationals of the member countries are allowed to invest in real estate and stock markets of the member countries (Gulf News, 2013). Today, the countries enjoy low inflation, similar levels of nominal interest rates and stable bilateral exchange rates. The GCC states recognize the prominence of the US dollar in global trade relations. Thus, a majority of the transactions are done using the US dollar (Hassanain, 2017). Today, the most traded commodity in the region is oil, which contributes a large proportion of the GCC revenues. It is also worth mentioning that the member states have pegged their currencies to the US dollar, except for Kuwait. Consequently, the GCC currencies have exhibited an antiquity of coordinated exchange rate fluctuations against the US dollar. There have also been stable cross exchange rates. The Business Cycle Typically, the business cycle pertains to the rise and fall of economic activities in the aggregate economy that occurs over a given period of time. A business cycle often goes through four distinct phases, namely expansion, trough, peak, and contraction (Amadeo, 2017). The GCC countries experience an expansion of the business cycle when the economy is growing consistently. At this time, the GDP expands continuously, and the economic output is recorded as positive (Medhioub Jedidia, 2017). Markedly, a majority of the GCC countries are reported to record high levels of economic growth and high GDP levels. The second phase of the business cycle is the peak. Naturally, this is the phase that the cycle transitions from the expansion stage towards the contraction period. During the contractionary phase, the GCC economies experience significant declines in the level of activity in the aggregate economy. Normally, the GDP growth rate falls below 2 percent. In the event that the growth level drops further towards negative, the economy may fall into a recessionary period. At such a time, the levels of unemployment rise substantially. After the contraction phase, what follows is the trough. By and large, this is the period in which the economy moves from the contractionary phase towards the expansion stage. During this stage, the economy hits bottom before recovering and transitioning towards expansion. It is crucial to point out that the business cycle is a continuous cycle that transitions between phases with respect to the economic performance of the member countries. What Drives the Business Cycle in GCC? By and large, the business cycle is influenced by the underlying economic conditions within the union. However, the most predominant factor that influences the business cycle is the level of the prevailing oil prices (Iqbal, 2014). As such, oil is a major commodity in the gulf region. Predominantly, it is a chief contributor to the economys GDP (Iqbal, 2014). For this reason, fluctuations in the general price level of oil and oil products have a significant effect on the level of GDP recorded in the country. Particularly, when the prices of oil go up, the level of GDP of the union also rises. Subsequently, this increases the level of activity in the aggregate economy, thereby enhancing employment opportunities in the region. In turn, this leads to the expansion of the economy. In contrast, when the prices of oil drop significantly, the revenues received by the countries also decline. In turn, this leads to the shrinking of the GDP in the member countries. Consequently, this leads to a decrease in the level of activity in the aggregate economy. Eventually, this increases the level of unemployment in the union, creating contractionary effects in the economy. What is more, the business cycle is influenced by global trade. Specifically, this affects the business cycle of the UAE. Predominantly, this is because the non-oil exports for this economy accounted for about 75 percent of its total exports in 2013 (Iqbal, 2014). Likewise, the prevailing interest rate levels affect the unions business cycle (Iqbal, 2014). One can attribute this to the fact that the currencies are pegged to the dollar. For this reason, the global interest rates also affect the local interest rates significantly. Furthermore, global demand for the GCC countries exports influences the business cycle. Monetary Policy- Conventional Primarily, monetary policy refers to the actions of the monetary authority tasked with the responsibility of determining the level and growth of the money supply in the economy. Markedly, conventional monetary policy pertains to the actions of the monetary authority in maintaining the economic stability in the country. By and large, monetary policy in the GCC is maintained through the regulation of the level of interest rate, and selling or buying government bonds, among others (Raghu, 2013). Normally, the monetary policy implemented in the region is either expansionary or contractionary. It is imperative to note that the union has transferred its monetary policy duties to the US Federal Reserve. Therefore, all monetary policy decisions are undertaken by the US Federal Reserve (Raghu, 2013). In this regard, the union has an obligation to mimic and implement the policies as directed by the Fed, regardless of its domestic economic underpinning. Luckily, this arrangement has worked to the advantage of both parties with regards to economic and business cycles of the GCC and the US. It could be noted that the cycles of the two economies are roughly synchronized (Raghu, 2013). Monetary Policy-Non-Orthodox Pegged Currencies In 2002, the union adopted a common currency and pegged their currency to the new currency. At the time, the GCC authorities agreed to peg the mutual currency to the U.S dollar (Fasano, 2003). The adoption of the pegged currency facilitated and eased the transaction process between the various countries in the union given the importance of the US dollar. As such, it allowed for a myriad of exchanges between the GCC countries and the rest of the world. Ever since its adoption, the dollar peg has provided a foundation and reference point for macroeconomic policy, confidence and stability in the region. However, over time, Europe has gained importance in the world economy. Thus, the union made way for trade arrangements with the European Union. In turn, this has led to the emergence of changes in the economic structure and exports across the union. Consequently, this has created the need for other options apart from the initial pegging to the US dollar. Specifically, this has paved the way for options such as pegging to a basket of currencies. This way, trade transactions between the two regions is smoothened and made relatively easier. Balance of Payments and Long-run Purchasing Power Parity The balance of payments encompasses all international financial transactions undertaken by the residents of the GCC. By and large, the balance of payment is calculated by summing up the values of the current account to that of the capital accounts of the GCC countries (Amadeo, 2016). On the other hand, purchasing power parity compares different countries economies through a market basket of goods (Al-Hassan, 2009). According to a survey done between 1990 and 2007, the relative PPP does not hold for GCC countries (Al-Gasaymeh Kasem, 2016). In turn, this indicates that the creation of a single currency for the union is not a good idea. Medium-Term Current Account Imbalance Over the past few years, the current account surpluses of the GCC states have been growing significantly. In 2007, for example, the surplus increased by about 30 percent of the GDP (Peeters, 2011). Before the global crisis of 2007, the money flowing into the economy was almost equal to the money flowing out of the economy. Positive trade balances offset the deficits in the balance of service and outflow of remittances. Essentially, for GCC countries, the current account balance as a percentage of the GDP is estimated as the sum of all the current account balances of the member states divided by the aggregate nominal GDP of the member states. Short-Run Asset Markets Predominantly, the asset market comprises of capital items which are more volatile and vulnerable to prevailing economic conditions. Between 2000 and 2008, the GCC capital account was negative (Peeters, 2011). Principally, this reflects the continuous change in domestic ownership of assets. Specifically, it indicates that the change in domestic ownership of foreign assets in the region surpassed the foreign ownership of domestic assets. Thus, the net investments by the union overseas were higher than the net investments by foreigners in the GCC. For this reason, the balance of their FDI, portfolio and other investments are negative. Conclusion All in all, the question remains as to how much the current exchange rates arrangements of the Gulf Cooperation Council are sustainable. To some degree, the current arrangement has acted as a basis for economic stability and macroeconomic policy in the union. It is sustainable to the extent that the regime has kept the union afloat for the years that the arrangement has been operational in the region. However, beyond that, it can be argued that the current exchange rate regime is unsustainable for the GCC economies. Primarily, this is because pegged currency keeps fluctuating with changes in the US dollar. Specifically, any small fluctuations in the US dollar and US policies significantly influence the rates in GCC countries. In turn, this creates instability in the region. Therefore, it is crucial for the GCC to find other sustainable current exchange rate arrangements. Reference List Al-Gasaymeh, A Kasem, J. (2016). Long-Run Purchasing Power Parity and Exchange Rates: Evidence from the Middle East. The International Journal of Business and Finance Research, 10(2), pp.42-46. Al-Hassan, A. (2009). A Coincident Indicator of the Gulf Cooperation Council (GCC) Business Cycle. 1st ed. [ebook] International Monetary Fund, pp.4-26. 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Journal of Knowledge Management, Economics and Information Technology, 1(7), pp.2-20. Raghu, M. (2016). GCC needs monetary policy independence. [Online] Gulf News. Available at: https://gulfnews.com/business/sectors/banking/gcc-needs-monetary-policy-independence-1.1909260 [Accessed 14 Feb. 2017].