Monetary Unions among Developing and Emerging Markets

1. Monetary Unions among Developing and Emerging Markets By Temitope W. Oshikoya, PhD, FCIB Director General, West African Monetary Institute, Accra, Ghana

2. Outline • Introduction • Optimal Currency Area • WAMZ VS GCC -Structural Convergence -Nominal Convergence -Economic Distance • Common Market • Financial Integration • Conclusion

3. Introduction • While the world has been fixated on the global financial meltdown, the WAMZ and the GCC will soon decide on the merits and timing of a single currency each for their respective countries and regions. • The WAMZ was formally launched by the Heads of State and Government of The Gambia, Ghana, Guinea, Nigeria and Sierra Leone, in December 2000, with the objective of establishing a common central bank and introducing a single currency by 2003 later postponed to 2005 and 2009 • The authorities of the GCC countries comprising Bahrain, Oman, Qatar, Saudi Arabia, Kuwait and United Arab Emirate decided in 2001 to establish a monetary union by 2010. • The GCC had a long term horizon for monetary union while WAMZ had a short term

4. Monetary Union and OCA . Benefits • Allows exchange rates (ER) to be fixed and therefore reduces ER uncertainty that hampers trade and investment. • Reduces transaction costs associated with multiple exchange rates. • Allows economies of scale • Reduces the ability of speculators to affect prices and disrupt the conduct of monetary policy and economize on reserves • Reinforces discipline and credibility of monetary policy especially in inflation-prone countries. • Expands bilateral trade among the countries of the Union

5. Monetary Union and OCA Costs • Loss of independence of monetary and exchange rate policies • The cost of policy autonomy could be very high in countries relying on seigniorage revenues • Cost of coordinating policies and those associated with the possible break down of the currency union

6. Monetary Union and OCA Requirements • Openness • Factor Mobility • Degree of Commodity Diversification • Similarity of Production Structure • Price and Wage Flexibility • Similarity of Inflation Rates • Degree of Policy Integration • Homogeneity • Political Factors

7. WAMZ VS GCC-Structural Convergence

8. WAMZ Countries: Population, GDP Growth and Size of Economies (2008) 8 Bubble size: scaled to population 7 Gambia Ghana 6 Sierra Leone Nigeria 5 Guinea 4 Real GDP Growth (%) 3 2 1 0 -100 -50 0 50 100 150 200 250 300 350 400 Size of Economy (US $'bil) PPP Sources: The World Factbook, CIA, April 2009 edition, World Development Indicators: 2008 Structural ConvergenceRelative size

9. WAMZ VS GCC-Structural Convergence

10. GCC and WAMZ Comparison • In WAMZ the structure of production is static, the GCC achieved massive progress in the past three decades resulted in a 30 to 35 percent decline in oil's contribution to GDP, compared to 65 to 70 percent in the mid-1970s. • Saudi Arabia constitutes about half of GDP of GCC, Nigeria, represents about four-fifths of the GDP of WAMZ.

11. GCC and WAMZ Comparison • GCC are wealthier than WAMZ countries. • With the largest oil and gas reserves, and very small populationsaverage per capita income for the GCC is US$23,548.2 against WAMZ of US$1,286.8 • In WAMZ there is only one major oil-producer, all GCC countries are oil-producing.

12. Economic Distance Output Growth: Nigeria as target Country 0.80 0.60 Gambia 2001-2008 Sierra Leone Gambia 1993-2000 0.40 1993-2000 Ghana 2001-2008 0.20 Ghana 1993-2000 Guinea 1993-2000 Sierra Leone 0.00 2001-2008 Nigeria -2.00 0.00 2.00 4.00 6.00 8.00 10.00 12.00 -0.20 Correlation Coefficient -0.40 -0.60 Guinea 2001-2008 -0.80 -1.00 Standard deviation Economic Distance

13. Economic Distance Output Growth: Saudi Arabia as target country 1.00 UAE 2001-2008 Kuwait 2001-2008 Correlation Coefficient 0.80 Bahrain 2001-2008 0.60 UAE 1993-2000 Qatar 1993-2000 0.40 Qatar 2001-2008 Oman 1993-2000 0.20 0.00 Saudi Arabia -1.00 0.00 1.00 2.00 3.00 4.00 5.00 6.00 Bahrain 1993-2000 -0.20 Oman 2001-2008 Kuwait 1993-2008 -0.40 Standard Deviation Economic distance

14. Economic Distance Inflation:Nigeria is the Target Country 1.20 1.00 Ghana 2001-2008 0.80 Ghana 1993-2000 Gambia 2001-2008 0.60 Gambia 1993-2000 0.40 Sierra Leone Correlation Coefficient 0.20 1993-2000 Nigeria 0.00 -1.50 -1.00 -0.50 0.00 0.50 1.00 1.50 Sierra Leone Guinea 1993-2000 -0.20 2001-2008 -0.40 Guinea 2001-2008 -0.60 Standard Deviation Economic Distance Economic distance reduces with integration process

15. Economic Distance Inflation: Saudi Arabia as target Country 1.20 Correlation Coefficient 1.00 Oman 2001-2008 Kuwait 2001-2008 UAE 2001-2008 0.80 Qatar 2001-2008 Bahrain 2001-2008 0.60 UAE 1993-2000 Bahrain 1993-2000 0.40 Kuwait 1993-2000 0.20 Qatar 1993-2000 0.00 Saudi Arabia -0.80 -0.60 -0.40 -0.20 0.00 0.20 0.40 0.60 0.80 -0.20 Oman 1993-2000 -0.40 Standard Deviation Economic Distance

16. Common Market

17. Financial Integration • WAMZ • Financial integration - important element of any regional integration process, especially for a monetary union. • The financial sector must be adequately prepared to promote financial inclusion and sustain a changeover to a new currency. • Some countries in the WAMZ have established stock exchanges but they operate within the confines of the national boundaries and few linkages to other member countries • Interbank and money market dominated by banks • Institutional investors participation limited • Capital market requirements differ significantly • Cross listing of stocks is limited. • Most countries of the WAMZ are reforming their capital accounts to attain full liberalization

18. Financial Integration • GCC • Liberal capital flows and pegged exchange rate • Well capitalised banking system • GCC stock markets outperformed emerging and developed markets • Rise in FDI • Currency - currently pegged to the US dollar • No clear plan for establishing common capital market

19. Financial Integration • WAMZ • Financial integration is an important element of any regional integration process, especially for a monetary union. • Cross-border retail payments are generally non-existent • Interest rates are however converging • Insurance market growing but penetration low • Banking sector integration on the rise- Nigerian banks driving the process

20. Financial Integration Bank Density in the WAMZ • Low bank density indicate high degree of concentration for both WAMZ and GCC, • Weak cross border branch activity a challenge for the efficient use of funds

21. WAMZ VS GCC-Nominal Convergence 21

22. WAMZ VS GCC-Inflation Convergence

23. WAMZ VS GCC-Fiscal Convergence • GCC • Countries • Operated • Fiscal • Surpluses • While the • WAMZ • ran Fiscal • Deficits

24. WAMZ VS GCC-External Sector Convergence Exchange Rate for the GCC is pegged to the US$- WAMZ to a basket of currencies

25. WAMZ VS GCC-External Sector Convergence

26. Necessary conditions for successful Monetary Union • Economic convergence • Structural convergence • Market convergence • Legal convergence • Political convergence

27. Summary • GCC has longer time perspective than WAMZ • Asymmetric shocks • Similarity of production • Geographical location • Richer in terms of resources and per capita income • Stable exchange rate • Low inflation • Low fiscal deficit • More institutionally prepared • Establishment of GCC Monetary Council the equivalent of WAMI

28. Conclusion • The journey towards a Monetary Union is a marathon and not a sprint race • The Euro Zone took over 43 years to achieve the common currency • The GCC countries decided in 2001 to establish a monetary union by 2010 but a postponement is being contemplated

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