If Assinment

8/3/2019 If Assinment

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The International Monetary Fund has approved plans that will

achieve monetary union for Middle Eastern countries by 2005

and the launch of a single currency by 2010.[1] The IMF's

policy discussion paper states: "The general conclusion is thatthe benefits do not seem too large, but that neither do the

costs."[2] The IMF has mapped out the steps that will be taken

during the unification period to establish the single Gulf

currency within the first decade of the new millennium.[3]

The new currency will initially be limited to members of theGulf Cooperation Council, which includes some of the most

wealthy nations on earth. The GCC Gulf comprises Saudi

Arabia - the world's most important source of oil, as well as

Bahrain, Kuwait, Oman, Qatar, and United Arab Emirates.

According to the IMF:

"The establishment of an economic and monetary union

will create an important regional entity that in 2001 had

an estimated combined GDP of about $335 billion, average

weighted per capita income in nominal terms of $12,708,

and 45 and 17 percent, respectively, of the world's oil and

natural gas reserves."[4]


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CURRENCY UNLIKELY: Gulf Arab countries are unlikely to

launch a single currency in the next 5 years due the preparationsrequired. (Getty Images)

Gulf Arab countries are unlikely to launch a planned single

currency in the next five years given all the preparation

required, the head of the Gulf Cooperation Council said on

Tuesday.

Abdulrahman al Attiyah, Secretary General of the GulfCooperation Council (GCC), also said he expected the UAE andOman, which quit the single currency project, would eventuallyjoin the monetary union but not until after the currency had beenlaunched successfully.

Last year, GCC abandoned an initial 2010 deadline for issuing

common notes and coins. It has not specified a new timeframefor the launch but many analysts see 2015 as a likely launchdate.

In a written response to questions emailed by Reuters, Attiyahsaid: "In a reflection to the sophisticated nature of the technical,


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legislative and institutional requirements, I don't foresee thecurrency to be launched in 2015."

Four Gulf countries pursuing the union - Saudi Arabia, Kuwait,

Qatar and Bahrain - launched a forerunner for a Gulf centralbank in March, but declined to reveal a roadmap for a singlecurrency

Gulf monetary union wasdesigned to emulate the euro zone and Attiyah said the GCCshould draw lessons from the euro zone debt crisis. He indicatedthat the return of the UAE and Oman was still on the cards, butrather at a later stage.

The UAE withdrew from the project a year ago in protest at

a decision to house the Gulf monetary council in the Saudi

capital Riyadh. Oman quit the project in 2006 and has

repeatedly said it was unlikely to rejoin anytime soon.

Attiyah said: "The UAE and Oman are neither objecting to

the project nor eliminating the possibility to join. In fact,

they are supporting the project by being active members in

the technical loop with respect to the single payment system

and the harmonized banking supervision legislations."


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He added: "The monetary union project is in the preparatoryphase and the possibility for both countries to be part of it

remains high, especially if a successful and strong currency

is launched."Monetary union in the region has been delayed by old politicalrivalries as some countries did not want Saudi Arabia, thelargest Arab economy and the world's top oil exporter, to holdtoo much influence.

Kuwait's plan to stick to pegging its dinar to a currency

basket for the foreseeable future also raised questions as theother three countries favour their currency links to the US

dollar. Attiyah, however, said that was not a problem.

Attiyah said: "The current exchange rate scheme in Kuwait

is not an obstacle by all means since the Kuwaiti dinar still

moves closely in an almost identical path with the rest of

GCC national currencies."

He added: "It is rather an enlightening experience for the

future central bank when manufacturing the single exchange

rate policy."

Kuwait's decision in 2007 to ditch its dollar peg to contain

strong inflationary pressures raised scepticism since Gulf

countries had agreed to keep their currencies tied to the

dollar.

Analysts consider the dollar peg to be the best fit for a single

Gulf currency, at least in the initial stage, as other regimes

would make budget oil revenues more volatile.


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In March, the Saudi central bank governor was appointed

head of the Gulf monetary council, underscoring the

kingdom's dominance and reducing the likelihood of either

the UAE or Oman joining the union.The UAE central bank governor said on Monday, that rejoiningthe union was off the table at the moment, while Oman saidrepeatedly it would not reconsider its decision.

The six nation GCC is a loose economic and political bloc

with its secretariat operating as its executive body with

prerogatives similar to those of the European Commission.(Reuters)

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Are GCC Countries Ready for Currency Union?

By

Belkacem Laabas and Imed Limam *April 2002

* Economists at the Arab Planning Institute, Kuwait.1Are GCC Countries Ready for Currency Union?

ABSTRACT

Using formal and informal criteria, we test whether GCC is anoptimum currency

area (OCA). Based on the traditional OCA criteria, we find thatGCC countries areyet to fulfill the necessary pre-conditions for the establishmentof Currency Union
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(CU). The structure of their economies remains dominated bythe oil sector, intraregionaltrade is very limited and, unlike what many believe, there does

not seem tobe evidence of convergence in their main macroeconomicfundamentals norsynchronization of their business cycles. The more formal testbased on theGeneralized Purchasing Power Parity Theory (G-PPP), showsthat real exchangerates in GCC are closely related and share the same stochastic

trend and hence pointsto the readiness, although to different degrees, of the countriesof the region for CU.We argue that the main factors that are favorable for theestablishment of CU are thecommitment by all GCC countries to fixed exchange ratearrangements and a strong

political resolve to achieve economic integration. Despite thelack of diversificationand actual weakness of intra-GCC inter-industry trade, CU, onceestablished, canexpand intra-industry trade among GCC if the proper steps aretaken toward morespecialization and sophistication of their respective industries.On the other hand, CUmay result in more synchronized business cycles provided thatGCC countriesachieve convergence in their economic structure, policies andregulations. In order to


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achieve these potential benefits of CU, GCC countries need toaccelerate economicintegration and fulfill the requirements of the GCC common

market through thelifting of all restrictions on the free movement of goods andfactors, and the creationof supranational institutions that would subordinate nationalinterest for the regionalone. This would be possible only if individual countries arewilling to surrendersome of their national prerogatives in favor of the interest of the

region as a whole.21. Introduction

In May 25, 1981, the countries of the Arab Gulf region,

Bahrain, Kuwait, Oman,

Qatar, Saudi Arabia and the United Arab Emirates, have

ratified the charter

establishing the Cooperation Council for the Arab States ofthe Gulf (GCC countries

hereafter). In their second Supreme Council meeting held in

November 1981, the

GCC leaders have adopted an Economic Agreement (EA)

setting the stage for a full

economic integration. The agreement had set out broad lines

for the realization of

coordination, integration and cooperation in various aspects

of economic affairs. The

Council has taken the necessary steps toward realizing the

different stages of a full


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economic integration namely, a free trade area, a customs

union, a common market

and economic union. The intensification of cooperation in

the relevant areas has beenachieved through the formation of various specialized

committees whose goal has

been to implement the guidelines of the main constituent

bodies of the GCC (the

Supreme Council, Ministerial Council and the Secretariat

General).1

As a first step toward economic integration among the

countries of the region, aFree Trade Zone was established in 1983. A decision to move

ahead with the next

phase of integration, through the establishment of a Customs

Union, came at the

Riyadh Summit of the Leaders of GCC countries in 1999. A

timetable was approved

to establish a Customs Union by the year 2005. Already intheir Bahrain summit of

the year 2000, the GCC leaders have agreed to adopt a

common peg for the different

currencies of the member states as a preliminary step

toward adopting a single

currency, considered a cornerstone for achieving full

economic integration.

During the last GCC summit December 30-31, 2001 in

Muscat, the six GCC

countries have agreed to a joint customs tariff of five percent

by the year 2003, two


17/66

years earlier than originally planned, and voted to create a

single currency by the

year 2010. As an intermediate stage toward establishing a

single currency, they havealso agreed to have the American dollar as a common peg

for their currencies before

the end of the year 2002.

1 See Peterson (1988, p. 149). Further details about theachievements and the official documents of GCC canbe found in the GCC Secretariat General web-site at:http://www.gcc-sg.org.

3In their desire to achieve monetary integration and a

common currency, the GCC

countries hold the common belief that the complete

integration of product and factor

markets requires the elimination of the transaction costs and

uncertainties associated

with the existence of separate currencies. However, theworthiness of establishing acommon currency has been traditionally tested against severalbenchmarksestablished by the theory of Optimum Currency Areas (OCA)and developed byMundell (1961), McKinnon (1963) and Kenen (1969). Manyrefinements of thetheory of OCA and the development of more sophisticatedformal verification of theoptimality of many Currency Union (CU) experiences in theworld, have allowed adeeper analysis and evaluation of such experiences.


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From this perspective, we propose in this paper to develop ageneral frameworkto assess the preparedness of the GCC countries for CU. In

section 2, we present abrief rationalization of CU and its costs and benefits. In section3, we test theoptimality criteria to assess the degree of preparedness of GCCcountries for CU.More formal tests of optimality are presented in section 4.Section 5 discusses thepotential impact of the GCC CU experience based on the

characteristics of itsmember countries. Concluding remarks are provided in section6.2. Optimum Currency Area: Definition and Potential

Benefits

First, it important to clarify some of the concepts often used

in the literature of

OCA. Broadly speaking .an OCA is a region for which it isoptimal to have its own

currency and its own monetary policy..2 Therefore, OCA

can interchangeably be

called Monetary or Currency Union. It involves monetary

integration, a single

currency and a common central bank controlling the pool of

foreign exchange

reserves and administrating monetary policy for the union.

Monetary integration, on

the other hand, involves the irrevocable fixing of the

exchange rates, full and


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complete convertibility of currencies, financial market

integration (measures to

liberalize capital transactions and harmonize national

financial regulations andstructures of institutions), the complete liberalization of

current transactions and a

common monetary policy.3 In the present paper, we assume

that CU is the

arrangement that the GCC countries are trying to achieveby the year 2010. The2 Frankel and Rose (1996), p.14.

3 We owe these definitions to Tavlas (1993), p. 665.4attempt of GCC at achieving a common peg before the end ofthe year 2002, can beconsidered a form of Exchange Rate Union.Optimality of a CU is often measured by the realization ofseveral criteria that

determine a priori the likely success of an OCA. These criteriaevolve around howintegrated countries of the potential group are with one anotherin terms of trade andother economic relationships as well as the extent of correlationin their businesscycles and similarity of shocks they are subject to.An OCA is desirable to the extent that it allows exchange rates(ER) to be fixedand therefore reduces ER uncertainty that hampers trade andinvestment.4 OCA isalso desirable to the extent that it reduces transaction costsassociated with multiple


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exchange rates. These costs relate to monitor ER fluctuations,cost of information topredict ER movements, the cost of currency conversion, and the

cost associated withthe need to keep and manage reserves for intra-regional trade.OCA also allowssome economies of scale to take place in terms of freeing idlereserves, enhancingthe role of money as a unit of account and as a means ofpayment. In addition, OCAmay help reduce the ability of speculators to affect prices and

disrupt the conduct ofmonetary policy and economize on reserves in case of offsettingpaymentsimbalances.5A further advantage of an OCA is that it may reinforcediscipline and credibilityof monetary policy especially in inflation-prone countries. The

credibility ofmonetary policy can be enhanced by attaching the latter to alow-inflation anchorcurrency. This was for instance the case of the high inflationEuropean countries ofItaly, Spain and Portugal in the 1970.s that wanted to tie theirrespective ER to thatof Germany for its credibility for fighting inflation.Equivalently, countries adopt acommon currency and fix its parity against a major currency as away to attachcredibility to a fixed-exchange rate regime by surrendering thepower to alter ER.


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The main disadvantages of an OCA is the loss of independenceof monetary andexchange rate policies. Exchange rates are irrevocably fixed

against one another,interest rates are tied to foreign interest rates, and any increase inmoney stock will4 This advantage is sometimes downplayed by the fact thatempirical studies did not find overwhelmingdetrimental impact of ER variability and by the very existence ofmeans of hedging against ER risk.5

result in balance of payment deficits. The monetary andexchange rate instrumentsplay an important role in economic adjustment as stabilizers.When countries areinvolved in hand-tying institutional arrangements such as theones related to anOCA, they give up these important policy instruments resulting

in important outputand employment losses. However, this apparent cost is mitigatedto the extent thatshocks for all the countries in the region tend to be symmetric soas to justify acommon response, or if there are mechanisms making theadjustment to such shocksoccur more promptly. This would be the case if prices andwages are very flexible orif labor and capital are mobile across members of the OCA. Thecost of policyautonomy could also be very high in countries relying onseigniorage revenues such


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as the case for countries with underdeveloped tax systems.6Other costs not emphasized in the literature are those associatedwith

coordinating policies and those associated with the possiblebreak down of thecurrency union. The latter costs are often factored in the OCAagreement by makingit difficult for countries to exit or to break the rules such asthrough imposingsanctions on violators. This is, for instance, the case of theEuropean Monetary

Union (EMU).A relatively more recent strand of literature has emphasized thatthe mainbenefits of CU stem from the expansion of bilateral trade amongthe countries of theUnion.7 For instance, Rose (2000) has found that trade amongthe countries of a CU

could triple after the start of the union. Some have argued thatthis might be toooptimistic due to some inherent upward bias in the estimationdue to the endogeneityof the decision to join a CU (Tenreyro (2001)), or to lumpingtogether members ofCU and countries commonly using the money of a largercountry in the same sample(Yeyati (2001)).Several factors have been identified in the literature fordetermining whether acountry is ready to join an OCA. These factors are related to thecharacteristics that


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would make stable exchange rates and currency union moredesirable. These are:5 Ishiyama (1975).

6 Tavlas 1993, p. 673.7 See for instance, Frankel and Rose (1996), Rose (2000) andRose and van Wincoop (2001).6i. Openness: A small country that is largely dependent oninternational trade is more likely to be affected byexchange rate fluctuations and uncertainty since a largeportion of its goods is tradables. McKinnon (1969) argues

that the ER in the case of a small open-economy becomesredundant as an instrument to correct balance of paymentsproblems. In this case, the exchange rate is strongly linkedto the price level in the economy to the extent that anyvariation in the ER is translated into variation in costs.Hence, the ER becomes an ineffective tool to improvecompetitiveness. In addition, Ishiyama (1975) argues for

instance, that for a small open economy where a large partof consumed goods are imported and in the absence ofdomestic substitutes, the ER becomes an ineffectivecorrective tool given the inelastic demand for imports.8For all these reasons, it is easier for a small open economyto enter into a currency union.ii. Factor Mobility: In case of a shock, if two countries arehighly integrated in the sense that labor and capital canfreely move from one country to another, there will be alesser need for the country affected by the shock to usethe ER as a corrective tool. From this perspective, factormobility plays the role of a substitute to the ER, ormonetary policy for that matter, as an adjustment


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mechanism should a shock occur. Therefore countrieswith more mobile factors of production are bettercandidates for currency union.

iii. Degree of Commodity Diversification: If an economy ismore diversified, it is better insulated against terms oftrade, and other, shocks, and hence is less prone to use theexchange rate to mitigate the impact of the shock.8 The GCC countries are a case in point.7Therefore, countries with diversified economies are bettercandidates for CU.

iv. Similarity of Production Structure: Countries that sharecommon production structure are more likely toexperience symmetric shocks and to exhibit highcovariation in economic activities. They are less likely touse their exchange rates as an adjustment tool and henceare better candidates for CU. It should be noted thatstructural shocks could also be symmetric (or correlated),

in addition to similarity of economic structure, because ofdependence on common foreign shocks such as thefluctuation of the price of oil in international markets.v. Price and Wage Flexibility: The flexibility of prices andwages obviates the need to alter the ER in case of shocks.Countries with flexible prices and wages are moreinclined to engage into CU arrangements that wouldrestrict the use of ER as an adjustment tool.vi. Similarity of Inflation Rates: Similar inflation rates signalsimilarity in structure and in the conduct of economicpolicies. This would be desirable for countries that wouldlike to coordinate their policies to achieve therequirements of a CU.


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vii. Degree of Policy Integration: The similarity of policyattitudes is an important indicator for the potential successof policy coordination that will be required to achieve full

monetary integration.viii. Political Factors: The success of CU would depend to agreat deal on the political will and resolve of membercountries to achieve the goal of CU. Experience hasshown that the political factors might be more importantthan the economic criteria.8In the next section, we test these optimality criteria to assess the

degree ofpreparedness of GCC countries for CU.3. GCC Countries and the Optimality Criteria for OCA

The purpose of this section is to verify whether the criteriamentioned abovequalify the GCC countries for OCA.i. Openness: The GCC countries are considered among the most

open economies in the Arab region. Openness is traditionallymeasured by the ratio of trade to the Gross Domestic Product(GDP). Table 1 gives the openness measures for the GCCcountries. These ratios varies from one country to the other.The high ratios observed for GCC countries reflect in part thenature of their factor endowment, being primarily oilexportingcountries. It also reflects the heavy reliance of thesecountries on imported consumer and capital goods owing tothe limited availability of domestic substitutes. These factorscombined limit the effectiveness of the ER as a tool to improvecompetitiveness or to reallocate resources among sectors.Table 1

Openness of GCC Countries


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YEARS BAHRAIN KUWAIT OMAN QATAR S.ARABIA

UAE

1980 226.50 90.00 84.56 90.90 88.98 96.05

1985 169.03 75.63 77.14 68.86 52.66 69.301990 164.21 56.50 67.67 70.98 65.47 83.281995 131.97 77.46 68.67 84.53 61.13 85.401996 145.59 75.89 71.63 73.08 62.62 85.691997 130.98 74.53 71.77 62.97 61.06 89.171998 109.40 72.46 70.03 74.23 55.50 87.02Average (1980-1998) 153.95 74.64 73.07 75.08 63.92 85.13Source: World Bank, World Development Indicators CD-ROM

2000.ii. Factor Mobility: Articles eight and nine of the UnifiedEconomic Agreement between the GCC countries haveallowed for the free movement of capital and individualsacross GCC countries and the freedom to exercise economicactivities. The work of many specialized committees has alsoforged the way toward concretizing the very principles

established by the agreement. However, looking at the extentof joint venture and labor movement among GCC countries, it9is clear that factor mobility cannot be relied upon as analternative adjustment mechanism to the ER. GCC still imposerestrictions on ownership and type of activities that GCCnationals could exercise. On the other hand, labor marketregulation and institutions are not very similar. This, inaddition to factors related to welfare state, preclude labor frommoving across GCC countries.iii. Degree of Commodity Diversification: Despite many effortsat diversifying their economies, GCC countries remain heavilydependent on oil. On average oil represents more than 80


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percent of export receipts and budget revenues, respectively.Table 2 gives the normalized Hirschman export concentrationindex for the GCC countries together with a group of

comparator countries.9 It shows the higher level of exportconcentration of GCC countries and hence the limiteddiversification and higher vulnerability of these countries toexternal shocks.Table 2

Export Concentration Indices for GCC Countries

Country 1980 1995

Bahrain 0.790 0.629

Kuwait 0.732 0.940Oman 0.922 0.765Qatar 0.934 0.731Saudi Arabia 0.942 0.743United Arab Emirates 0.870 0.619Brazil 0.148 0.088Korea 0.085 0.148

Israel 0.264 0.274Turkey 0.230 0.112Source: UNCTAD (1999).Even the non-oil sector in GCC is perceived as an enclavewhose development depends to a large extent on theperformance of the oil sector. Productive activities in the nonoilsector are very limited and a high share of the non-oilaggregate value added originates mainly from trade and9These rates are taken from UNCTAD (1999). They werecomputed based on the 3-digit SITCclassification, revision 2. A value of the index closer to zeromeans more export diversification and viceversa.


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10business services. As a consequence, the economies of theGCC remain vulnerable to the fluctuation of oil prices in

international markets. However, despite being exposed tofrequent terms of trade shocks, GCC countries adopt acommon policy stance in which the ER is not considered as apolicy instrument that can be adjusted in case of adverse oilshocks. In fact, the adjustment operates mainly through theGovernment expenditures instrument.iv. Similarity of Production Structure: Broadly speaking GCCcountries have the same production structure with a dominant

oil-sector and a limited non-oil sector dominated by trade andfinancial and business services. The sectoral distribution ofGDP presented in table 3 shows the degree of similarity inproductive activities. Coupled with the dominance of oil, thesimilarity of production structure is likely to entail symmetricshocks that would eventually call for common policy reactionsamong these countries.

v. Price and wage flexibility: Prices and wages do not adjustsystematically to accommodate frequent oil shocks. Asmentioned earlier, Government expenditures are the mainstabilizer of economic activities during recessionary oilmarkets. However, the limited role of prices and wages as11Table 3

Sectoral Composition of the GCC GDP

Bahrain Kuwait Oman Qatar S. Arabia U.A.E.

1992 1996 2000 1992 1996 2000 1992 1996 2000 1992 1996

2000 1992 1996 2000 1992 1996 2000

Agriculture, Hunting, Forestry and


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Fishing 1.2 1.2 1.0 0.4 0.5 0.5 2.9 3.1 3.3 1.3 1.2 0.6 7.6 7.5 8.32.4 3.0 3.7Mining and Quarrying 21.4 22.6 23.6 43.0 55.5 46.0 50.9 52.3

48.3 48.5 51.2 61.4 46.8 47.1 40.8 47.3 37.1 30.2Manufacturing 14.3 18.3 16.5 12.5 14.8 16.0 4.6 5.0 5.3 15.610.0 7.8 10.4 10.9 12.7 9.2 11.6 15.3Electricity, Gas and Water 2.2 1.9 2.3 -1.8 -0.1 0.0 1.1 1.1 1.51.5 1.7 1.6 0.2 0.2 0.2 0.6 1.5 1.7Construction 7.4 5.4 5.4 5.0 3.2 3.5 4.0 2.7 4.0 5.8 9.1 5.8 10.310.3 11.6 9.8 9.4 9.5Wholesale and Retail Trade,

Restaurants and Hotels 18.0 15.8 13.7 15.1 8.4 9.4 16.1 16.317.8 9.0 10.2 8.0 8.3 8.3 8.9 11.7 13.7 14.8Transport, Storage and

Communication 10.8 9.0 9.5 6.5 5.2 7.4 6.9 7.7 10.5 4.2 4.9 5.27.5 7.3 8.2 6.2 7.1 8.3Financial Institutions and Insurance 24.2 24.7 26.0 4.1 4.17.8 3.1 3.9 6.5 15.5 13.7 11.1 6.9 6.5 7.4 4.9 6.4 7.0

Real Estate and Business Services 11.9 11.8 11.7 13.9 8.8 11.110.6 8.8 7.1 0.0 0.0 0.0 0.0 0.0 0.0 7.2 10.9 10.0Community Social and Personal

Services 4.8 4.6 5.2 4.0 2.2 2.8 2.2 2.0 0.0 2.5 2.2 1.9 3.3 3.2 3.72.6 1.8 2.0(Less) Imputed Bank Service 16.3 15.3 14.8 na 2.7 4.6 2.4 2.94.3 3.9 4.3 3.5 1.3 1.4 1.7 1.9 2.4 2.5Total Industries 100 100 100 100 100 100 100 100 100 100100 100 100 100 100 100 100 100Source: Computed by authors based on data from the StatisticalYearbook of the ESCWA Region 2000, United Nations.12adjustment mechanism in GCC countries does not qualify the


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ER as an alternative mechanism to either prices, wages orGovernment expenditures. In other words, the limited flexibilityof prices and wages in GCC countries does not affect the ability

of these countries to qualify for currency union to the extentthat the ER is eliminated as an option for adjustment.vi. Similarity of inflation rates: GCC are not inflation-pronecountries. However, inflation rates seem to be pro-cyclicalpicking up at periods of oil price hikes and decreasing duringperiods of oil price slumps. Inflation rates across GCCcountries are not highly correlated despite a relative similarityin the conduct of macroeconomic policies namely, fiscal,

monetary and ER policies. This might seem to suggest thatinflation differentials among GCC countries reflect adifference in the microeconomic determinants of inflation (i.e.factors affecting the supply of and demand for goods andservices) notably, the presence of price inertia.vii. Degree of policy integration: Many efforts have beendeployed

by the GCC countries to reinforce commonalities andcoordinate many facets of economic and social policies.Article 4 of the GCC charter stipulates, among other things,the formulation of similar regulations in the economic andfinancial affairs. The main policies that call for coordination inthe context of CU have already common features in thecountries of the region. For instance, monetary and exchangerate policies in the GCC countries are commonly centeredaround maintaining a wedge between domestic and foreigninterest rates in order to stabilize the ER and stem capitaloutflows or portfolio reallocation in favor of foreign assets.viii. Political factors: GCC leaders have shown a strongcommitment to this regional grouping. This commitment stems


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from the many common traits shared by GCC countriesnotably the similarity in their political, social, demographic13

and cultural structures.10 Despite the fact that the tempo ofeconomic integration has incurred minor setbacks anddecelerations, it did not affect the resolve of GCC leaders toreinforce cooperation and move ahead with economic andpolitical integration. Even if integration is moving at a muchslower pace than is generally hoped, GCC countries are oftenpraised for taking a pragmatic approach consisting ofprogressively reinforcing commonalities rather than hastily

imposing unrealistic conditions to achieve such integration.11If we consider the above factors as informal tests or eligibilitycriteria for CU by theGCC countries, we could summarize the situation as follows:Table 4

GCC Countries Eligibility Test for OCA

OCA Criterion Favorable Unfavorable

Openness Factor Mobility Commodity Diversification Production Structure Price and Wage Flexibility Similarity of Inflation Rates Degree of Policy Integration

Political Factors Judging by these optimum currency area criteria, the priorconditions are not all favorablefor CU. Does this mean that GCC countries need to provide thenecessary conditions to


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fulfill these eligibility criteria and to delay the process of CUuntil these conditions are met?The immediate answer is NO. Does this mean that by 2010 all

the conditions mentionedabove will necessarily be met and only then GCC countriescould establish an OCA? Theanswer here again is NO.10 Peterson (1988, p. 106).11 Peterson op. cit.14As for the first question, the recent literature on OCA has clearly

indicated that theso-called eligibility criteria are generally met ex post rather thanex ante. In fact, the EMUwhich is considered a historically unprecedented experience inmonetary integration, hasbeen carried through while few members did not fulfill theabove criteria. In fact,

Eichengreen (1990) shows for instance, that the Europeancountries in the euro zone displayless favorable conditions for CU than the different states of whatis actually known as theUnited States of America before they became a federation ofstates.More intra-regional trade could be generated and business cyclescould become morealigned within the countries of the group after the launch of theOCA. But then the questionneeds to be raised differently: Will GCC OCA generate moreintra-regional trade and more


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correlated business cycles among the countries of the group?The analysis in the next sectionwill address this prospective question in more details.

Coming to the second question on whether GCC countriesshould wait for the year2010 to establish OCA, the NO answer could be justified basedon the experience of EMU.i. The European Monetary Integration Experience in a

Nutshell:

The idea of a single currency for Europe has been an objectiveever since the creation

of the European Common Market in the wake of the treaty ofRome in 1957. Based on theirhistorical aversion to exchange rate fluctuation and during theHague meeting in 1969, acommittee headed by the prime minister of Luxembourg, PierreWerner, presented aproposal in what has come to be known later as the Werner

report, suggesting locking EUexchange rates and the establishment of a federated system ofEuropean Central Banks. Theplan was postponed after the collapse of the Bretton Woodssystem. In 1979 the Europeancommunity decided the creation of a network of mutuallypegged exchange rates aimed atproviding monetary stability for the region. The System hascome to be known as theEuropean Monetary System (EMS) or the Snake. The exchangerates were allowed to

fluctuate within a band of 2.25%relative to an assigned parvalue. Following many events


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such as the German unification and the higher capital mobilityand fiscal expansion withinEurope, there was a pressure on the Deutschmark to appreciate

that was accompanied by aspeculative attack on the EMS on September 1992. As a result,the fluctuation margins of the

EMS were widened to up to 15%. The United Kingdom andItaly have chosen to exitEMS.15The frequent currency realignments operated after the EMS (11

realignments between1979 and 1987) has led the EU, in 1988, to reconfirm theircommitment to a EuropeanMonetary Union (EMU). In 1989 , a committee headed byJacques Delors has set theobjective of an economic and monetary union (EMU) wherebynational currencies are to be

replaced by a single currency managed by a centralized CentralBank (ECB). The road mapfor the project with an explicit plan and timetable were approvedin the Maastricht Treaty in1991. The treaty has set a three-stage plan to establish the euro:

Stage 1: Removal of remaining restrictions on capitalmovements (July 1990).

Stage 2: Establishing the European Monetary Institute (EMI)as a precursor of a European Central Bank and imposing fiscaldiscipline on the public sector (July 1, 1994).

Stage 3: Irrevocably fixing bilateral exchange rates (January 1,1999).


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Convergence criteria to be fulfilled by potential candidates forEMU were set interms of inflation rates, exchange rate stability, budget deficit,

and Government debt. InJanuary 1999, the euro was introduced as a scriptural (non-cash)money. The euro has beenintroduced as a one-for-one replacement of the EuropeanCurrency Unit (ECU).12 Thebilateral central rates of the currencies of the countries of theeuro zone against the ECUhave been used as benchmarks to determine the irrevocable

conversion rates at which theeuro has been substituted for individual countries. currencies.13In January 2002 euro coinsand banknotes were introduced. A transitional period for the co-existence of the euro andnational currencies was allowed until February 28, 2002. Theeuro zone actually comprises

the following countries:.Belgium. Germany. Spain. France. Ireland. Italy12 The ECU has been created as an international currencywithin the EMS. It consists of weighted averages ofcurrencies of the European Community Countries. All countriesparticipating in the EMS have agreed tolimit variation of their currency parities with respect to thecentral rates defined in terms of ECU.


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13 See for instance, Temperton (1998) for further details aboutthe creation of the euro.16

. Luxembourg. Netherlands

. Austria

. Portugal

. Finland

. Greece (from 1 January 2001)The remaining three European Community member statesnamely, United Kingdom,

Sweden and Denmark, have decided to opt out of the euro zonebut may join in the future.ii. Comparing the European and GCC Experiences:

At prima facie, the experience of the European monetaryintegration and that of theGCC countries are not strictly comparable from the premise thatthe former is at a more

advanced stage than the latter. However, it is still useful to havea clear idea about wherethe more recent GCC experience could benefit from theEuropean one.EU and GCC have a very common attitude toward CU. Bothhold the view that thecomplete integration of product markets requires the eliminationof the transaction costsand uncertainties associated with the existence of separatecurrencies. The EU reliesstrongly on the argument that economic integration withoutmonetary integration cannot


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provide a political equilibrium. On the other hand, it is widelybelieved that monetaryintegration requires political integration in order to lend

credibility to Government.scommitments to pursue fiscal policies that are consistent withprice stability andpreservation of the monetary integration.14 GCC countries seemto follow the footsteps ofthe EU in that respect. However, the political integration is yetto be seen in the case of theGCC countries. In the EMU experience, the decision to create a

European Parliament anda European Central Bank as supranational entities designed tosafeguard monetaryintegration came ten years before the launching of the euro.There is no clear time table ora formal plan for the establishment of such entities in the case ofGCC. Only the loose

deadline of end of the year 2002 to finalize the procedures of acommon peg to theirrespective countries, was set.In addition, the EMU experience is based on Germany, and to alesser extent France,as a driving force of the euro zone. Most of the countries in theeuro zone have attachedtheir currencies and monetary policies to Germany given its highcredibility in fighting14 Eichengreen (1996).17inflation. This helps achieve convergence and coordination ofpolicies between the partner


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countries. In the case of GCC countries, such a focal point forconvergence simply doesnot exist.

More importantly, the European experience in achieving CU hasfocused on theMaastricht convergence criteria to impose the necessary fiscaldiscipline to preservemonetary integration. GCC countries are yet to establish such amechanism.An additional factor that made the birth of the euro lesscomplicated is the legacy of

EMS, which is a system of tying up currencies within a narrowband. The existence of acommon denominator, ecu, consisting of a synthetic basket ofEuropean currencies madethe transition to the euro a relatively easy operation. The eurowas simply set as a one-tooneratio with the ecu.

The GCC countries have relatively similar exchange ratearrangements. Up untilDecember 31, 1999, Bahrain, Qatar, Saudi Arabia and UAE pegtheir respective currenciesto the SDR; Oman to the U.S. dollar and Kuwait to a basket ofcurrencies determined onthe basis of the currencies of its major trade and financialpartners. Recently Bahrain andQatar switched the peg of their currencies from SDR to thedollar. In practice, all GCCcountries. currencies hold a stable relationship to the dollar. Thisexplains the recent


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decision of GCC countries to establish the dollar as the commoncurrency their domesticcurrencies are to be pegged to. The implementation of this

intermediate stage will be a stepforward toward establishing the common GCC currency. Thispre-commitment to fixedexchange rates may help demonstrate the resolve of GCC tofinancial discipline andachieve the necessary credibility for monetary integration.4. Testing OCA for GCC: Generalized Purchasing Power

Parity Approach

The Generalized Purchasing Power Parity Approach (G-PPP)for assessing the viabilityof forming a currency area was developed and tested by Endersand Hurn (1994). The mainidea of the approach starts from the fact that real exchange ratesof the countries potentiallycandidates for a currency union area are non-stationary. This is

so because the fundamentalmacroeconomic variables (forcing variables) that determine realexchange rates are also nonstationaryand follow different growth paths. For countries to qualify for asuccessfulcurrency area, they should experience convergence andsymmetrical shocks to theirfundamentals. The latter should move together and besufficiently interrelated so that the real18exchange rates will have common stochastic trends. Therefore,the theory advocates that the


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real exchange rates within a currency area should be co-integrated. This means that thebilateral real exchange rates of the countries of the currency area

should have at least onelinear combination that is stationary.The G-PPP test consists of finding whether there arecointegrated vectors betweenthe exchange rates of the CU. In other words, one should testwhether an equilibriumrelationship exists between the different bilateral real exchangerates such that:

......... (1) 12t0 13 13t1n 1nt t RER RER RER where it RER1 is the real exchange rate between the basecountry and country i in period

t, 0 is the constant term and ij are the parameters of thecointegrating vector and represent

linkages among the economies of the currency area, and tis awhite noise disturbance term.

The real exchange rate series are constructed using twoalternative base countriesnamely, Kingdom of Saudi Arabia (KSA) and the United Statesof America (USA). Thechoice of KSA as a base country is obvious given the economicimportance of the Saudieconomy in GCC, and may represent the dominant country in

forming a successful currencyarea. However, the choice of the USA is also important giventhe tight relation of GCCcurrencies with the US dollar.The real exchange rates that we use are defined as follows:t


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t t

t P

RER S P

*where t S is the nominal exchange rate expressed as the numberof national currency unitsfor one unit of the currency of the base country. *t P

and t P are the consumer price index inthe base and the home country, respectively. The resulting real

exchange rates are plotted inFigure 1. The annual data form 1960 to 1999 on nominalexchange rates and consumer priceindices for GCC and USA were obtained from the IFS CD ROMof the IMF (2002) andWorld Development Indicators CD ROM of the World Bank(2001). For computational

purposes, we use the logarithm of the real exchange rates asdefined above.19During the past two decades, GCC.s currencies have fluctuatedonly moderately giventheir close relationship to the US dollar. There is also a strikingsimilarity of the variation inthe nominal dollar rates of GCC currencies. The coefficient ofvariation is almost the samefor all GCC countries (0.11) except for the Omani Riyal whichfluctuated less than the otherGCC currencies (0.06). In fact, the Bahraini Dinar did notchange from the rate of 0.377 BD


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to the dollar since 1981. The Omani Riyal was also fixed at therate of 0.3845 riyal to thedollar since 1987, the UAE Dirham at 3.677 since 1981, the

Saudi Riyal at 3.745 since 1987,and the Qatari Riyal at 3.64 since 1981. Only the Kuwaiti Dinarhas fluctuated within a verynarrow margin. Despite this apparent stability of GCC nominalexchange rates since the1980s, the ADF stationarity test applied to a longer samplereveals that GCC nominal ratesare in fact non-stationary.15 This can be attributed to the

fluctuation of the nominal exchangerates prior to the period 1980-1999. The GCC rates computedagainst the Saudi Riyal alsoreflect the same picture. However, the volatility of the GCCcurrencies with respect to theSaudi Riyal is less than that of the US dollar.Real Exchange rates computed for both base countries (USA

and KSA) exhibit highervolatility than nominal exchange rates. In fact, the coefficient ofvariation is almost doublethe coefficient of the nominal exchange rates. The ADFstationarity test shows that realexchange rates in GCC are not stationary.15 In fact, when the ADF test is applied to GCC data samplefrom 1980 to 1999, it turns out that nominalrates are stationary.20Figure 1

Real Dollar Exchange Rates of GCC 1960-1999

.20


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.25

.30

.35

.40.45

.50

.551960 1965 1970 1975 1980 1985 1990 1995Bahrain.22.24

.26

.28

.30

.321960 1965 1970 1975 1980 1985 1990 1995Kuwait3.0

3.13.23.33.43.53.63.71960 1965 1970 1975 1980 1985 1990 1995Qatar.0.1.2.3


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.4

.5

.6

.7.81960 1965 1970 1975 1980 1985 1990 1995Oman1.52.02.53.0

3.54.04.51960 1965 1970 1975 1980 1985 1990 1995KSA2.02.5

3.03.54.04.55.05.51960 1965 1970 1975 1980 1985 1990 1995UAEThe first step in testing G-PPP is to see whether the realexchange rates in the GCC arein fact non-stationary. From the casual inspections of the graphsof such variables, it is


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apparent that the RERs are not stationary. This hypothesis isconfirmed by the formal tests ofDickey Fuller (1979) and Phillips Peron (1988). The results of

these tests and for the twobase countries are given in Table 5. It is clear from the table thatnominal and real exchangerates are not stationary. The null hypothesis that the datageneration process contains a unitroot in the exchange rate data cannot be rejected. However, thetest is rejected at the 5%21

level when applied to the first differences of nominal and realexchange rates. Therefore,both series are integrated of order one.The second stage in testing the OCA consists of conductingcointegration analysis. TheJohansen (1991, 1995) approach to the estimation and testing ofcointegrated relationships is

used. Both trace and maximum eigenvalues tests are used todetermine the number ofcointegrating equations. The trace statistic tests the nullhypothesis of r cointegratingrelations against the alternative of k cointegrating relations. Themaximum eigenvaluestatistic tests the null hypothesis of r cointegrating relationsagainst the alternative of r+1relations.n order to estimate the parameters of the cointegratingrelationships, we need todetermine the lag length of the Vector Autoregressive (VAR)model underlying the long-run


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relationship given by equation (1), so that estimation is possibleand error terms areapproximately white noise. However, due to the small sample

size and severe dataunavailability, we could not experiment with high-order VARmodels. In our case, VAR(1)seems to fit the data reasonably well and the errors terms of themodel are fairly wellbehaved.Table 6 gives the results of testing for the number ofcointegrating vectors in terms of

maximum Eigenvalue, max , trace, trace , statistics, and thecorresponding eigenvalues, .16As can be seen from the table, the trace test suggests theexistence of up to three

cointegrating vectors, while the max suggests four. These testswere conducted at the 90percent significance level. Since the results were not in perfect

agreement and to minimizethe risk of failing to reject an incorrect null hypothesis, wereconducted these tests using the95 percent critical values given by Osterwald-Lenum (1992).

The max and trace criticalvalues for r=3 were 21.07 and 31.52, respectively. Hence, thehypothesis of the existence of

three contegrating vectors or less is accepted. Upon furtherobservation, the 95 percent

significance level max test accepts the null of r=2, since the 95percent critical value was27.14, higher than the computed value of 25.48.


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16 Given that no clear trend was detected in the data, interceptswere only included in the cointegratingrelationships.

22Table 5ADF Stationarity Tests of GCC Exchange Rates

Base Country = USA Base Country = KSANominal Real Country Nominal RealLevel 1st Differences Level 1st Differences Level 1st

Differences Level 1st Differences

Bahrain (66-98) -1.20 -3.69 * -0.52 -2.61* -0.40 -2.59* -0.65 -

4.09*Kuwait (72-98) -0.80 -4.16* +0.87 -5.27* +0.08 -5.30* -0.60 -3.34*Oman (60-99) +0.119 -3.74* -1.10 -3.23* +1.27 -4.27* -0.38 -7.00*Qatar (79-99) -1.30 -3.54* 0.78 -2.62* -0.58 -2.35* -1.89 -2.04*SA (63-99) -0.75 -3.66* -0.122 -2.14* - - - -

UAE (73-99) -1.32 -3.61* 1.36 -3.58* -0.57 -3.15* -0.53 -3.06*23Table 6

Testing for Cointegration

Trace max__________________________________________________________

H0 H1 Stat. 90% H0 H1 Stat. 90% critical value critical valuer = 0 r > 0 196.36 97.17 r = 0 r = 1 101.44 25.51 0.995

r 1 r > 1 94.92 71.66 r = 1 r = 2 39.63 21.74 0.876r 2 r > 2 55.29 49.91 r = 2 r = 3 25.48 18.03 0.739


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r 3 r > 3 29.80 31.88 r = 3 r = 4 16.29 14.09 0.576r 4 r > 4 13.51 17.79 r = 4 r = 5 8.51 10.29 0.361r 5 r > 5 5.00 7.50 r = 5 r = 6 5.00 7.50 0.231

Based on these results, we conclude that there are twocointegrating vectors. The

estimates of the cointegrating vectors,, and the associatedadjustment coefficients vectors,

, are presented in table 7.Table 7

Cointegrating and Adjustment Vectors *

Constant Bahrain Kuwait Oman Qatar SaudiArabia U.A.E.

1 -1.609 -0.458 -0.188 -0.019 1.302 1.000 -1.9521 --0.280(-7.733)-0.166(-2.281)

-0.006(-0.024)-0.119(-4.243)-0.419(-13.350)-0.058

(-1.124)2 1.884 -0.307 1.566 -0.579 -0.645 1.000 -1.4702 --0.057(-1.826)


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-0.047(-0.760)0.626

(3.121)0.010(0.397)0.130(4.837)0.173(3.881)* The cointegrating vectors are normalized so that Saudi

Arabia.s exchange rate is the reference.T-values are in parentheses.

While the coefficients may be interpreted as long-termelasticities, the s are theadjustment coefficients indicating the speed of adjustmenttoward long-term equilibrium.24

Overall, the presence of cointegrating relationships is a formalproof that G-PPP holdsand that GCC meet the requirements of a CU. However,cointegration is a statistical conceptand it is often very difficult to give sound economicinterpretation to all cointegratingrelationships. In our case, we favor the first cointegrating vector

on the ground that alladjustment coefficients have the appropriate negative sign. Theexchange rates of all GCC,except Oman, enter this cointegrating relationship significantly.The zero restriction


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Likelihood Ratio test for the Omani exchange rate could not berejected at the 95 percentlevel. This may reflect the fact that Oman is the least favorable

candidate for CU. Thisinterpretation is compatible with the relatively low correlationbetween the macroeconomicfundamentals of Oman and those of the other GCC countries.17

Furthermore, the .scoefficients for Oman and the UAE are very small and representa slower adjustment processto the equilibrium equation in the sense that deviations from G-

PPP can persist for arelatively long period of time. Differences in adjustment speedmay also reflect differencesin country circumstances that would call for different policymeasures. From thisperspective, Oman and UAE may be considered a lesshomogeneous subset than the rest of

GCC countries for the constitution of a CU.It should be noted that many G-PPP-based tests in the literaturereject the OCAhypothesis despite stronger correlations between forcingvariables than those observed in thecase of GCC. Overall, we find that G-PPP holds for the case ofGCC. This ratherunconventional result can be rationalized, putting aside datalimitations and modelingdifficulties, by the fact that GCC represent a rare case whereexchange rates are stable andanchored strongly to the US dollar and inflation rates arerelatively similar.18 This result,


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however, does not preclude forcing variables from drifting apartand should not beinterpreted as a sign of convergence among the economies of

GCC. The success of GCCmonetary union requires that more policy coordination andsynchronization be undertaken,and further steps to create a single market where all restrictionson the movement of goodsand factors be removed.17 See table 11.18 To test the sensitivity of the results to sample limitations, the

stationarity and cointegration analysis werecarried out using monthly data for Kuwait, Bahrain, and KSAusing more than 200 observations. Weobtain the same results: the exchange rates for these countr ieswere cointegrated.255. Potential of GCC Currency Union

As argued earlier, the benefits of a currency union are long-termwhile its costs areimmediate. In the long-run, the creation of a single currencymay boost intra-regional tradeand investment and may help, over time, to reduce countrydifferences and achieveconvergence with respect to economic policy. However, thefulfillment of these long-termgains relies on features and characteristics of the countries of thegrouping.Despite the signing of a free trade area, inter-GCC trade remainsweak. The share of


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intra-GCC commodity exports in the total exports of eachcountry remains very limited.The average for these shares during the period 1989-1999 are

21.3% for Bahrain, 1.6% forKuwait, 17.1% for Oman, 6.3% for Qatar, 6.6% for SaudiArabia and 4.6% for U.A.E. Thestagnation of these shares rather than their weaknesses is themore alarming. The degree ofintra-GCC trade integration, as shown in Table 8, is relativelyweak in comparison withother economic blocs in the world.

As shown previously in table 2, the limited diversification ofGCC exports offers verylimited possibilities of expanding inter-industry trade. Inaddition and as argued byPeterson (1988), the existence of similar second industries in thedifferent GCC countries.could generate long-term detrimental structural overlap. that

would stifle efforts todevelop regional trade.We argue, however, that a single currency might reinforce intra-industry trade if therespective GCC countries achieve concerted efforts at increasingspecialization andimproving the technical sophistication of their industrial sectorseven in the oil-derivativesindustries.26Table 8

Regional Trade Blocs Exports within Bloc as

% of Total Exports of the Bloc


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1970 1980 1990 1999

EU 59.5 60.8 65.9 62.9NAFIA 36.0 33.0 41.4 54.6

APEC 57.8 57.9 68.3 71.9CEFTA 12.9 14.8 9.9 11.9MERCOSUR 9.4 11.6 8.9 20.5CEMAC 4.8 1.6 2.3 1.6GCC 2.9 3.0 8.0 6.8UMA 1.4 0.3 2.9 2.5Source : WDI (2001)Table 9 that follows gives the Intra-Industry Indices (IIT) in

Manufactures for GCCand other comparator countries. The table reveals that GCCcountries exhibit low levels ofIIT despite the efforts of countries like Bahrain, Oman andSaudi Arabia, at expandingtheir industrial base. Unless, GCC countries put more efforts inintensifying industrial

specialization, the competition in second industries wouldundermine the efforts atexpanding intra-GCC trade.With respect to capital movement, GCC countries still imposevarious forms of controlon inward direct investment by GCC nationals. These controlsvary from prior approval(Oman) to limited ownership of capital (Kuwait, Qatar andU.A.E.) and restrictions ontypes of activities GCC nationals could engage in (Kuwait,U.A.E.). The complete liftingof these restrictions will be an important step toward setting upthe Gulf Common Market


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and the implementation of a pre-requisite for the realization ofthe benefits of CurrencyUnion.

27Table 9IIT in Manufactures for GCC Countries

Country 1985 1997

Bahrain 0.21 0.31Kuwait 0.12 0.08Oman 0.12 0.24Qatar 0.09 0.07

Saudi Arabia 0.09 0.19United Arab Emirates 0.28 0.28Brazil 0.51 0.54Korea 0.41 0.61Israel 0.59 0.66Turkey 0.16 0.33Source: Yeats and Ng (2000, p.22).

GCC have taken many measures aimed at mobilizing financialresources and facilitatingthe movement of people and capital. For instance, the GulfInvestment Corporation (GIC),established in 1982 with a capital of US$2.1 billion ownedequally by all GCC countries, hasfor objective the mobilization of financial resources for theimplementation of projectspromoting the productive sectors in the respective GCCcountries.Recently, national banks were allowed to open branches in otherGCC economies. The


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GCC also established the Gulf Network of the NationalAutomated Teller Machines (ATM).Many of the achievements reported in GCC General Secretariat

include .the practice ofretail and wholesale trade, ownership of shares and real estates,engaging in differentprofessions and economic activities such as agriculture,industry, contracting, animalresources, establishment of hotels and restaurants, establishmentof training centres, andobtaining loans from industry development funds and banks in

the GCC States..19The establishment of a common GCC currency is expected tohelp advance economicintegration by forcing member countries to deregulate their laborand product markets andeliminate any barriers to the free movement of capital. With asingle currency, arbitrage

19 Economic Achievements as described in the officialdocuments of GCC Secretariat General. See web-siteat: http://www.gcc-sg.org.28between countries with different market conditions becomeeasier and countries with the lessfavorable conditions will be affected negatively.Despite the apparent similarity among GCC countries and theprevious efforts atreinforcing commonalities, their business cycles do not seem tobe much synchronized.Tables 10 and 11 give the tests of mean and variance equality ofthe forcing variables of


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GCC and the crude measures of association between thesevariables, respectively.Table 10

Tests of Equal Mean and Variance of GCCMacroeconomic Fundamentals

Mean Variance

Inflation (CPI) 1.048 54.16*Inflation (GDP) 0.368 78.60*Per Capita GDP 81.498* 211.0150*Real GDP 78.60* 339.02*GDP Growth 2.567* 54.808*

Interest Rate (Deposit) 9.134* 20.193*Real Exchange Rate (USA) 379.68* 300.1772*Real Exchange Rate (KSA) 368.84* 600.26*Money Growth 0.388 40.151*Nominal Exchange Rate 1604.69* 429.07*Interest Rate (lending) 19.270* 34.174** Significant at 5%

Table 10 summarizes the t-test of equality of mean and thevariance of ten macrofundamental variables across GCC. The null hypothesis of equalmean and variance isstrongly rejected for all the variables except for broad monetarygrowth and inflation. Table11 gives the correlation matrices of these macro variables inGCC. It also reflects thedissimilarity in the behavior of the fundamental macroeconomicvariables. The correlationcoefficients of real GDP growth rates between GCC are notuniform and very disparate.29


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Table 11

Pairewise Correlation matrix

Output Money growth

Bahrain Kuwait Oman QatarKSA UAE Bahrain KuwaitOman Qatar KSA UAE

Bahrain 1.00 0.46 -0.15 0.47 0.54 0.06 1.00 0.38 0.44 0.28 0.370.40Kuwait 1.00 -0.018 -0.24 0.05 -0.08 1.00 0.69 0.70 0.67 0.51Oman 1.00 -0.36 0.02 -0.04 1.00 0.63 0.62 0.84Qatar 1.00 0.39 0.38 1.00 0.86 0.53KSA 1.00 0.41 1.00

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