IMF help sought on new currency

IMF help sought on new currency

By Nadim Kawach on Thursday, September 03, 2009

Saudi Arabia and three other Gulf oil producers have sought assistance from the International Monetary Fund on a possible revaluation of their currencies as part of a landmark plan to create the world’s second monetary union in 2010.

In a working paper released yesterday, the IMF suggested slight appreciation of the currencies of Saudi Arabia, Kuwait, Qatar and Bahrain against the US dollar, but it warned any leakage of news ahead of the revaluation could spur damaging speculation.

“This paper developed from an informal request to one of the authors by a member of the Gulf Co-operation Council (GCC) Secretariat for guidance on how to set the conversion values for the new GCC currency. He subsequently requested such advice from the IMF. This working paper describes one method that could be used for the conversion.”

The report said such a methodology could also be useful for the UAE and Oman in case they decide to join the GCC monetary union at a later stage.

“If hypothetically the GCC decides to establish the new currency in its original planned year, 2010, Saudi Arabia would need to revalue its currency by 2.94 per cent vis-à-vis the US dollar, Kuwait by 5.15 per cent, Qatar by 4.54 per cent and Bahrain by 1.09 per cent.The methodology provides an estimate of the required adjustment for each currency, if the conversion is to take place in 2011, 2012 or 2013,” said the working paper.

The paper said that because of these low estimates of the degree of misalignment, the GCC authorities might choose to not modify their current parity vis-à-vis the US dollar.

“In addition, if information of possible adjustments filters to the market, the agents might undertake speculative attacks that might undermine the exchange rate adjustment and could harm the creation of the new currency,” it said.

The paper said only a small exchange rate adjustment (less than five per cent) is needed for the GCC currencies to establish the conversion at the closest level to equilibrium.

“Moreover, the adjustment tends to decline from 2010 to 2013… we recommend that the GCC authorities rigorously apply our proposed method [alongside other methodologies and with full use of information available within the region] to test these results to help set the conversion rates for the future union,” it said.

“In a broader perspective, we recommend a regular update of the forecast misalignment using the bi-annual World Economic Outlook publications to monitor the conversion rate and make sure it is still the closest to the equilibrium value. It could also be useful to calculate the real exchange rate (RER) equilibrium and misalignment using forecasts from other databases or using the national agencies’ forecasts.”

The paper concluded that GCC nations could also construct several terms of trade variables that would reflect different oil prices and use these variables to calculate the RER misalignment to see how the different currencies would deviate from the equilibrium, and calculate the required exchange rate adjustment if any of the scenarios is to occur.

Oman pulled out of the planned GCC currency union in late 2006 on the grounds it is not ready for the project.

The UAE followed suit in early 2009 apparently to protest the GCC decision to locate the Gulf Central Bank in Riyadh not in Abu Dhabi.

GCC officials discussed the monetary union plan in Kuwait yesterday but there was no word whether the scheme would be launched on time next year.

The four members have not made clear what form of currency would be in circulation but some officials have indicated national currencies would remain in circulation in the first stages of the union. A new peg, possibly a basket of currencies, could be adopted then.

The currencies of Saudi Arabia, Qatar and Bahrain are pegged to the US dollar while Kuwait ended that peg and reverted to a basket in early 2008 because of soaring inflation, for which it blamed the dollar and other factors.

Hot money poured into the oil-rich region in late 2007 and 2008 on mounting speculation the GCC countries are about to revalue their currencies against the dollar to tackle inflation, which soared to double digits in most members.

Found the report it's 59 pages:

http://www.imf.org/external/pubs/ft/wp/2009/wp09184.pdf

MrsCK wrote:Found the report it's 59 pages:

http://www.imf.org/external/pubs/ft/wp/2009/wp09184.pdf

Starting to read this report tonight so will post highlights but this is cool:

A key issue in creating a new currency union is setting the rates to convert national currencies into the new union currency. Planned unions in the Gulf region and Africa are seeking methods to set the conversion rates when their new currencies are created. We propose a forward-looking econometric methodology to determine conversion rates by calculating the degree of misalignment in the real exchange rate, and apply it to the GCC currency union. For each GCC currency, we identify the year at which the economy is the closest to its internal and external equilibrium, and then estimate the degree of misalignment in the bilateral real exchange rate vis-à-vis the U.S. dollar based on WEO forecasts until 2013. Application of the methodology to other regions is also considered.

AFRICA?? They are as bad as the middles east on NOT getting along down there!!! OH wait the new USA puppet has family from there...oh what a great person to bring "peace" that region....guess the world bank picked the right guy for their purpose.

Page 3:

4. Identifying the equilibrium exchange rate at the conversion date is therefore essential. If an exchange rate is misaligned (overvalued or undervalued) at the time of the conversion into the union currency, it will be frozen at that misalignment leading to economic distortions across the union members. An undervalued entry would give rise to a higher competitiveness for the country in comparison with its partners in the currency union, and will require a higher than average inflation rate throughout the union to reduce the misalignment. An overvalued entry could involve significant costs in terms of unemployment and bankruptcies (Wren-Lewis, 2003). Therefore, the fair assessment of the misalignment for all members of the union is crucial.

So the IMF is saying that the countries need to get their currency's on the same playing field BEFORE the currency union???

Page 4

7. This effect has certainly occurred to some extent, but two issues were unresolved – whether the U.S. dollar monetary policy adopted as a result of the peg was appropriate for the region, and how to deal with inflation differentials between countries that change the real exchange rates between the GCC currencies. Both these issues became major concerns in the region. By late 2007, there was widespread concern that the dollar peg was contributing to overheating of the economies and causing large capital losses because of the dollar’s weakness in exchange markets. Numerous proposals for change were made, such as switching to a basket or announcing a large appreciation (20-30 percent) of the GCC currencies against the dollar. At the same time, rapid inflation in Qatar and the United Arab Emirates (UAE) affected their real exchange rates vis-à-vis the other GCC countries. The new union would need to address such issues and their possible effect on the conversion of national currencies into the new union currency,2 as is done in this paper.

Back then they had picked a revaluation of their currency's....which cause a lot of HOT money to go flying into the GCC waiting on the revaluation....with this document and the article...I think HOT money will fly in real fast again.

foot note on page 5:

3 In addition to the planned currency union among the GCC countries, projects are actively underway to develop unions in East, South, and West Africa. In many other regions of the world, discussions are underway about possibly building other currency unions, but they have not reached the point where projects to build unions have been launched.

Wow the currency's unions sure are starting up.

page 6:

13.
The creation of a currency union involves the creation of a new currency for the union that becomes the legal currency for all member countries. All preexisting national currencies are absorbed into the new union currency. With a single currency for all member countries there will be only one monetary policy and only one exchange rate for the union.

OK so each country will still have their own currency in the beginning but then it will slowing be taken off the market.

14. A critical step in the process is converting the individual national currencies into the new union currency. A conversion rate must be set to redeem the national currencies for the union currency and to redenominate all values expressed in the old national currencies into the value of the union currency.

So each countries currency needs to be close or the same as the Union currency so that is does not upset the trade...another good point to revalue their currency before.

Page 10:

24.
The GCC has now agreed that a Monetary Council will be set up in Riyadh to make arrangements for the planned currency union. One task of the Council will be to set the rates for conversion of national currencies into the new currency. This paper is intended to contribute to that effort.

Now this IMF document is from August.....so GCC has had this for awhile...wonder how far along they are??