The economics of the GCC monetary union
Much have been written on the progress of the GCC monetary union. So far, I haven’t written anything on this topic. Here is my chance! The question I want to explore is where these economies currently stand as an indication of an emerging monetary union. I will try to answer my question using two graphs I have recently come across.
Figures 1 & 2, taken from a recent paper by Marga Peeters, show the decomposition of GCC’s balance of payments. Such a decomposition is very useful as it allows to get an understanding of the extent of intraregional economic & financial integration. Consider first Fig. 1, which shows the decomposition of GCC’s current account balance, basically tells us the extent of intraregional trade integration. We can see that exports and imports of goods are the largest items in the current account. GCC’s exports are predominantly oil & gas, which are mainly sold outside of the GCC. So we need to concentrate on imports, which reflect the non-oil trade. According to a recent study by the World Bank, in 2007 the share of intra-GCC trade in non-oil trade was only 9%, compared to ASEAN (23%), NAFTA (41%), and EU-15 (57%). Although this fact is hardly surprising, it tells us how weakly GCC’s non-oil sector is integrated.
Besides trading goods, countries also trade services (e.g. banking, airline). You could already guess that GCC would fare even poorly in service trade, due to similarities in economic structures. So, for example, when both Qatar and the UAE simultaneously spend money in building fancy villas or commercial buildings, they are basically competing against each other, which may eventually led to overcapacity (think of empty buildings). Similar excess supply woes are looming other industries (e.g. petrochemical, cement, airline). Likewise, the attempt to turn almost every GCC country as a regional financial hub may prove to be a Pyrrhic victory.
This leaves us with the outflow of remittances, which mainly reflect the income transfers of foreign workers living in the region. By contrast, the inflow of remittance is practically invisible in Fig. 1, telling us that Saudis prefer to work in Saudi Arabia, and Kuwaitis in Kuwait. Overall, the current account paints a not so pretty picture of the extent of intra-GCC trade integration achieved so far.
Let’s us now analyze Fig. 2, which shows a decomposition of the capital account. As an economist, my favorite item in the capital account is FDI (foreign direct investment) inflow, because it is generally a long-term investment which can really benefit a country/region. However, in the GCC context, the bulk of the FDI inflow goes to the energy sector for extraction purpose, which does not directly contribute to the development of the non-oil sector. Most of GCC’s FDI outflow is invested elsewhere, for example, buying a boutique 5-star hotel is Paris. I will not comment much on the inflow/outflow of portfolio investments because of their questionable merit. These flows are basically short-term investments, difficult to isolate them from speculative capital (hot money), and often are a cause of market instability (particularly in emerging capital markets). Cross-border bank loan & deposit are important items, because they supposedly provide funds for projects. But these items are not a friend in need, because just when you need them more, they shrink (as can be seen from their dramatic drop in 2008, when in fact some projects in GCC required the financing from being either postponed or cancelled). So while the above data generally shows an improvement in cross-border financial flows within GCC in recent years, their true quality is difficult to fathom.
Finally, the substantial size of errors and omissions in both capital and current account is a case of GCC X-Files! Even after accounting for measurement errors and data uncertainty, such a large error is hard to swallow. A lack of transparency is an issue that will continue to frustrate economists for years to come.
All in all, the above discussion doesn’t paint a flattering picture of a promising prospect of the GCC monetary union. One starts to wonder whether all those high-level government meetings concerning the monetary union were a mere lip service, as genuine progress is hard to find in the economic data. Nonetheless, despite how little has been achieved, I am very hopeful about its future, as I believe that a sound GCC monetary union can positively contribute to the global economy—which will be the topic of my next post, Insha’Allah.
NOTE: GCC (Gulf Cooperation Council) includes Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (UAE). Oman and the UAE are yet to become official members of the GCC monetary union.