Alternative Exchange Regimes in Oil Exporting Economies: The Case of the Gulf Cooperation Council

Abstract

During the period between 2004 and 2008 the Gulf Cooperation Council (GCC) countries witnessed high levels of inflation. This was largely due to the US dollar pegged exchange rate regime operating in these economies at the time, and the depreciation of the US dollar over other major currencies during the same period.This research explores alternative exchange rate regimes available for the GCC, taking into consideration their size, wealth and economic performance. It also evaluates the possible effects on the private sector if an alternative regime is adopted. Finally, it assesses the readiness of the GCC economies to move towards a single currency and compares the GCC proposed currency union with the Euro experience.Researchers supporting fixed exchange regime believe that it leads to a better inflation performance according to Ghosh et. al. (1996), Hausmann et. al. (1999) and Eichengreen et.al. (1999). Others, like Caramazza et. al. (1998) believe that this is not standard for all emerging economies and also Collins (1996) supports a fixed regime for economies with poor growth, which is not the case for the GCC. On the other hand, Duttagupta et. al. (2005) and Velasco (2000) support a floating regime for economies with technical knowhow and an international trading volume. The move to a more flexible regime will lead to fluctuation in the nominal exchange rate, which is expected to affect the stock market performance according to Frankel et. al. (2007), Tian et. al. (2010) and Dornbush et. al. (1980). Other researchers such as Bartram et. al. (2012), Nieh et. al. (2002) and Tsai (2012) are of the view that this relation between the stock market and exchange rate doesn’t exist. Taking into consideration the size of the combined GCC economy and the integration between these economies, this support the move to a single currency union as the GCC forms an Optimum Currency Area. This move is supported by researchers like Laabas et. al. (2002), Rose (2000) and Pisani-Ferry (2012) who believe that a single currency union will increase intra-trading, liberate reserves and increase the trust of the union economies.The methodology adopted in this research combines both empirical approach and informal approach and compares the outcome from both methodologies. Tests such as Unit Root Test to examine stationarity, Cointegration to examine long-run relationship between variables, VAR and ECM tests for short-run relationship test and Granger Causality tests to examine if a variable can be used to forecast another variable were used in this research. In addition to the above formal approach, a Mundell-Fleming theory was introduced to examine the relationship between stock market and exchange regime and an informal theoretical analysis was presented to assess the GCC readiness to form a currency union.The main findings of the research can be summarized as follow:1. Analysis of economic indicators from the GCC supports the move towards a more flexible exchange rate regime.2. The effect of nominal currency fluctuation on the private sector is expected to be minimal in the short-run and managabele in the long run.3. GCC countries still have a long way to go if they are to form a currency union as the underlying infrastructure is weak.This research was conducted in the period between 2006 and 2015, which has witnessed an abnormal economic cycles, mainly the 2008 international financial crisis. This has led the author to eliminate some years following the 2008 crisis. Also, one of the main complications raised in this research was data collection, especially GCC related data. This has led to following different informal approaches to collect the required data for the research.