Currency Political Economy in the Gulf States Submission Date: 22, June, 2018 Submitted by: Khalid Tasawar Student number: 10772979 Department: Political Economy Supervisor: Lukas Linsi University of Amsterdam Amsterdam, the Netherlands Words: 18,946 Chapter I ........................................................................................................................................... 1 Introduction .................................................................................................................................. 1 Chapter II ......................................................................................................................................... 5 Literature review .......................................................................................................................... 5 The transformation of currency exchange from Gold standard to flexible/fixed .................... 5 Theoretical explanation ......................................................................................................... 7 Exchange regimes: Fixed versus Flexible ........................................................................... 8 Political economy theory ................................................................................................... 10 International Political Economy of Exchange rate regime ................................................ 11 Cooperation in International Monetary Relations ............................................................. 12 Exchange rate regime: National (domestic) politics.......................................................... 12 Interest groups and Regime choice .................................................................................... 13 Political Institution and Regime Choice ............................................................................ 13 Chapter II ....................................................................................................................................... 14 GCC currency exchange rate regime and its implications ................................................... 14 Literature Economic arguments ........................................................................................ 15 Literature Political Arguments .......................................................................................... 18 Domestic politics ............................................................................................................... 19 International level politics ................................................................................................. 20 The establishment of a common currency – The Khaleeji ........................................................ 22 Chapter III ...................................................................................................................................... 24 Methodology ............................................................................................................................. 24 Time frame ............................................................................................................................ 26 Chapter IV ...................................................................................................................................... 27 Hypothesis 1: A political regime is associated with the currency exchange politics in the GCC countries. .................................................................................................................................... 27 Hypothesis 2: Trade between the United States and the GCC countries force the Gulf States to remain pegged to the US dollar. ................................................................................................ 27 Hypothesis 3: Oil economy forces the GCC countries to remain committed to the US-dollar peg. ............................................................................................................................................. 28 Results and Implication ........................................................................................................... 29 Hypothesis 1: ......................................................................................................................... 29 Hypothesis 2 ......................................................................................................................... 32 Hypothesis 3 .......................................................................................................................... 37 Chapter V ....................................................................................................................................... 40 Analysis ..................................................................................................................................... 40 Conclusion ..................................................................................................................................... 51 Bibliography .................................................................................................................................. 52 Appendix ........................................................................................................................................ 61 Chapter I Introduction In recent years, there is an external and internal pressure on the Gulf Cooperation Council (hereafter, the GCC) countries to change their currency exchange rate regime which is now pegged to the US dollar. The pressure originates from economic insecurity that includes lower purchasing power, real income and increased inflation. The inflation pressure has emerged in these countries due to an unstable oil price, a low US dollar value, a buoyant economic growth and an increasing import from Asia and Europe. The inflation rate has jumped from a single digit 0.2% between 1998 through 2002 on average in the GCC to a double digit between 9% through 10% by the end of the decade within the GCC countries. Additionally, the import price in the GCC countries have coincided with the consequent US dollar depreciation. Economists and politicians in the GCC consider the US dollar peg as the cause of the aforementioned problems. The GCC countries currency is pegged/fixed with the US dollar from 1980s. Exchange rate regime policies have a significant effect on almost all aspects of domestic and international economies of involved countries. Currencies and their values are central to the world economy. From the economic perspective, they affect international trade, investment, finance, migration, and travel. From the political perspective, they affect the "mass-consuming public, role of elections, organization of economic groups, power of particularistic interests, time horizons of voters and politicians, and responsiveness of political institutions to pressures along with virtually all other features of a national political economy" (Frieden, 2014, p.2). The prevailing exchange rate system often defines the international economic order. On a national level, "the exchange rate is the most important price in any economy, for it affects all other prices" (Frieden, 2014, p.9). For decades, it has been argued and confirmed that the exchange rate regime has a significant effect on macroeconomic outcome (Frenkel & Rapetti, 2010). The currency policy is the most important economic policy of a government, especially in an open economy, to the rest of world. In currency political economy, policymakers encounter two interconnected options. The first one is a fixed exchange rate regime, in which the monetary policy of a national currency is fixed to a commodity such as gold, a major currency or a basket of currencies. In 1 this case, the government has no authority on its monetary policy, meaning the governments with fixed currency regime will have a passive monetary policy. The second option refers to appreciation (high) or a depreciation (low) of the currency value. The latter phenomenon is only valid in a flexible/floating currency exchange regime. In the floating currency regime governments have the authority to intervene and influence demand and supply of their currencies, thus providing the local authority the autonomy to manipulate its currency value if needed. Currency exchange regimes are not restricted to these two. The IMF has classified at least eight types of currency regimes varying from purely floating to hard peg (IMF Report, 2016). The currency regime and level of exchange rate differs per country's national policy. These policies always involve trade-offs, and they have winners and losers, like all other policies. In the current era, all major currencies such as the United States dollar, the euro, the Japanese yen, the British pound, and the Indian rupee, are floating. These currencies, particularly the United States dollar, are widely traded. In contrast, some countries, especially the Gulf States, have fixed their currencies to the US dollar. This has recently been criticized and is also associated with slower economic growth (Setser, 2007; Buiter, 2008). In spite of association with lower economic growth, higher inflation rate and fierce political criticism, the GCC members have announced that they are committed to their fixed exchange rate regime. Therefore, it is a controversial issue for the economic and political science students/scholars. This paper attempts to explain the GCC currency exchange rate regime from political economy perspective since it