What can the GCC learn from the European experience of monetary union? Russell Krueger of the International Monetary Fund and Erwin Nierop from the European Central Bank offer an expert view.
This article summarises a joint presentation that the authors delivered at the GCC Currency Reform Conference held in June in Dubai.
At the time of the elaboration of this article, reports emerged in the media that the Governors of the GCC central banks and the Ministers of Finance of the GCC Member States had agreed on two draft legal instruments: a Monetary Union Agreement (MUA) and a Statute for a Gulf Monetary Council (GMC).
The objectives and tasks of the Gulf System of Central Banks (GSCB) would need to be clearly defined.
It was also reported that these drafts would be submitted to the GCC Heads of State for their approval during their yearly official summit, to be held in November 2008 in Muscat, Oman.
The legal instruments would then subsequently have to be ratified by the GCC Member States after completion of their respective national procedures in this respect.
The adoption of the MUA and the establishment of the GMC represent very positive developments for a number of reasons. Firstly, in addition to intentions already expressed by the GCC in the past, the adoption of the MUA will provide for a clear commitment at a political level with regard to the establishment of a monetary union.
Secondly, the MUA will no doubt elaborate the institutional framework for monetary union, so that all relevant parties (Member States, market participants, the public at large) may make themselves acquainted with the framework in which their monetary union and they themselves are supposed to operate.
Thirdly, the establishment of the GMC is expected to give a huge impetus to the technical preparations for monetary union.
Comparing the above developments with the European experience, the MUA of the European Union (EU) was the so-called Treaty of Maastricht, which was later merged into the Treaty on European Union.
The Treaty of Maastricht did not only detail the arrangements for Economic and Monetary Union (EMU), but it also contained a number of Protocols, which were an integral part of the Treaty, amongst which a Statute of the European Monetary Institute (EMI) and a Statute of the European Central Bank (ECB) and the European System of Central Banks (ESCB).
The EMI was the precursor of the ECB, mandated amongst other things to prepare for the EU's monetary union and, as such, the EMI could be compared with an architect firm designing the plans for monetary union.
However, established in 1994 and with a target date for the introduction of the EU's single currency, the euro, of January 1999 (at least for the scriptural euro, the physical banknotes and coins followed three years later in January 2002), the EMI acted partly also as a building company, erecting the technical infrastructure necessary to operate the monetary union.
Whilst the GCC's MUA and the Statute of the GMC are two important legal instruments, on the basis of the European experience and as also recognised in the communications emerging from the above Governors and Ministers meeting, there are at least three main areas which require further attention.
Firstly, assuming that the GMC will also (like the EMI for the ECB) be the precursor of a Gulf Central Bank (GCB), the Statute for the latter will have to be drafted.
Secondly, assuming that the GMC will have to conduct the technical preparations for monetary union, again like the EMI, it will have to identify the necessary actions (and communicate them to other parties whenever such parties will have to prepare themselves as well).
Thirdly, the arrangements for the changeover from the present currencies to the GCC's future single currency will have to be elaborated and communicated well in advance of the actual event to all relevant parties so that they can properly prepare themselves as well.
Each of these three topics will be further elaborated below, noting that the GCC's plans on the substance of its monetary union are not yet known and thus using the European experience as an example.
In this context, one comes back to what Erwin Nierop has already mentioned in ta previous interview: the EU may indeed serve as a useful example, but each region wishing to embark on monetary union will still have to reflect critically for itself as to which EU arrangements suit their specific needs and to what extent such provisions need to be tailored towards their own requirements. Statute of a central bank
If the GCC would like to take the Statute of the ECB/ESCB as an example, it would have to consider a large number of issues and the non-exhaustive list below is meant for illustration only.
Firstly, the constitutional set-up of the monetary union would have to be decided upon. Would the GCB, like the ECB, become a part of a system of central banks, the "Gulf System of Central Banks (GSCB)"?
A changeover scenario will have to be defined: A big bang or staggered introduction.
Since it is generally said that the GCC would like to create a European-style monetary union, it is assumed below that there will indeed be such a GSCB.
Secondly, the objectives and tasks of the GSCB would need to be clearly defined. For the ESCB, the primary objective is maintaining price stability, whilst the secondary objective is supporting the EU's economic policies.
The ESCB's main tasks are to: define and implement monetary policy; conduct foreign exchange operations; hold and manage the official reserves of the euro area Member States; and promote the smooth operation of payment systems.
Its other tasks are to: contribute to the smooth conduct of policies pursued by the competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system; submit opinions to EU institutions or to national authorities on matters in its field of competence; collect and standardise statistical data; for the ECB, decide on the international representation of the ESCB; and issue banknotes.
Thirdly, the organisation of the GSCB would have to be spelled out. The ECB has three decision-making bodies: the Governing Council; the Executive Board; and the General Council.
The Governing Council is composed of the Governors of the National Central Banks (NCBs) of the euro area Member States (at present 15) and the 6 members of the Executive Board. It formulates the ECB's monetary policy, amongst other matters, and it normally meets on a fortnightly basis.
The Executive Board is composed of a President, Vice-President and four other members. It implements the monetary policy of the Governing Council and is responsible for the current business of the ECB.
The ECB and the NCBS of the euro area Member States together are also referred to as the Eurosysthem in order to create a distinction with the ESCB.
The General Council is composed of the Governors of all EU NCBs (at present 27) and the ECB's President and Vice-President. It contributes to several auxiliary functions of the ESCB and meets normally on a quarterly basis.
Furthermore, the status of the NCBs would need to be addressed. In the ESCB, they are an integral part of the system and they act as the operational arms of the system, each in its own jurisdiction, but they may also have their own, non-system related tasks, unless such tasks interfere with the objectives and tasks of the ESCB.
Fourthly, a number of operational, financial, and legal issues will have to be settled.
For example: the ECB and the NCBs are empowered to conduct a large number of (central banking) operations; the ECB is endowed with a capital of euro 5 million (against capital shares held by all EU NCBs in accordance with a certain key) and the euro area NCBs are obliged to transfer up until 55 billion in foreign reserves to the ECB (again, in accordance with the above key); and the ECB may adopt different legal acts.
In certain areas such as monetary policy, the ECB may adopt generally binding and directly applicable regulations. It may also adopt decisions binding on the addressees as well as guidelines and instructions binding on the NCBs.
Furthermore, it may adopt non-binding recommendations and opinions (the latter in particular in those cases where the ECB is, and has to be, consulted on draft EU and national legislation in its field of competence).
Preparatory work is expected to cover a large number of areas, which are (again, non-exhaustively) listed below together with examples.
For most projects in these areas, a distinction may be made between three stages: (a) strategic/conceptual, (b) implementation/operational and (c) building and testing/technical.
• Establishment of the GMC (Headquarters, staffing, etc).
• Monetary and exchange rate policy (monetary policy strategy).• Operational framework for monetary policy and exchange rate policy (instruments, procedures).
• Banknotes and coins (name, sub-divisions, design, technical features).
• Market infrastructure for payments and securities transactions (in case of decentralisation, linking of systems).
• Prudential supervision of financial institutions and financial stability).
• Statistics (monetary and banking).
• Financial matters (a harmonised accounting method for the GSCB).
• IT infrastructure (secure communications between different parts of the GSCB).
• International representation of the GSCB (in financial institutions such as the IMF).
• Legal issues (the GSCB's regulatory framework).
• Establishment of the GCB (Headquarters, employment conditions).
• Changeover to the single currency (see further below).
The changeover from the present national currencies to the GCC's future single currency is obviously a major event for all parties involved: the GCC's citizens, administrations, market participants, etc.
They will have to be timely and properly informed and where appropriate consulted in order to ensure a smooth and undisturbed changeover. In this connection, again, a large number of different issues will have to be addressed and the issues mentioned below are, again, only indicative and not exhaustive.
The name of the single currency and its sub-divisions will have to be chosen and an uniform and consistent use of such names will have to be ensured. A changeover scenario will have to be defined (a big bang or a staggered introduction of the single currency).
The legal implications of the changeover will have to be settled covering issues such as: substitution of the single currency for national currencies; conversion and rounding rules; continuity of contracts; exchange and redemption of banknotes and coins; and redenomination of securities.
A changeover scenario will have to be defined (a ‘big bang' or a staggered introduction of the single currency). The changeover in the financial sector will have to be prepared (for example, the market infrastructure for scriptural payments will have to be adapted).
Furthermore, the cash changeover will have to be prepared. All logistical arrangements need to be prepared well in advance of the start of monetary union in order to ensure a smooth changeover (for example, vending machines need to be adapted).
All the above requires a communication strategy for the changeover (for instance: television spots; advertising campaigns in newspapers; and leaflets distributed to households).
With the adoption of both the MUA as well as the Statute of the GMC, the GCC will make two big steps forward towards the achievement of monetary union and these steps will in particular pave the way for further preparations for monetary union.
There are at least three main areas where such preparations should be made: the drafting of a Statute of the GCB; preparations in about twelve different areas to operate the monetary union; and the establishment of arrangements for the changeover of the present currencies to the GCC's future single currency.
At present, it is premature to estimate how much time this will take.
The timetable for the completion of preparatory work depends critically on a number of factors such as: the necessary and desirable arrangements for monetary union; those provisions which are already in place and those which have to be built from scratch on; the available resources; the possible outsourcing of certain actions; and, last but not least, the question to what extent the European experience may provide for useful examples.
Indeed, examples from the European experience may save valuable time.
This article reflects the views of the authors and not necessarily those of the IMF and the ECB.For all the latest banking and finance news from the UAE and Gulf countries, follow us on Twitter and Linkedin, like us on Facebook and subscribe to our YouTube page, which is updated daily.
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