University Economics: Monetary Policy and GCC Pegging to USD

This essay examines the monetary policy and exchange rate dynamics of the GCC countries and their decision to peg their currencies to the U.S. dollar. It begins by defining currency pegging and its purpose in stabilizing exchange rates, emphasizing its role in providing certainty for international transactions. The essay then explores the advantages, such as macroeconomic stability during global financial crises, and how it encourages economic growth. It also discusses the disadvantages, including the loss of monetary policy flexibility and the impact of U.S. interest rate changes on GCC currencies. The analysis considers the impact of fixed exchange rates on exports and imports, ultimately concluding that while pegging has benefits, it also presents challenges for the GCC economies, particularly their dependence on oil revenues.

Running head: MONETARY POLICY AND EXCHANGE RATES
MONETARY POLICY AND EXCHANGE RATES
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Topic: What are the advantages and disadvantages of the GCC pegging against the USD?
Introduction
Currency pegging can be defined as the concept of fixing the rate of exchange of a
currency by matching its value to the value of another currency or to any valuable metal like
gold or silver (Ng 2017). In other words, pegging of a currency refers to the controlling of the
value of that currency by fixing the exchange rate to the currency of another country, which is
comparatively more stable than the former one. It is also known as the fixed exchange rate
whose purpose is to stabilize the exchange rate between two or more countries (Gervais,
Schembri and Suchanek 2016). Hence, currency pegging provides the long term certainty of the
rate of exchange for business planning and many more economic activities such as imports and
exports. Thus, in this context, it can be said that dollar peg refers to the fixed exchange rate at
which a country fixes the value of its currency to the value of the U.S. dollar, and along with the
rise and fall of the value of the U.S. dollar, the value of the pegged currency also rises or falls at
a fixed rate. Almost 66 countries have pegged their currencies against the U.S. dollar and the
GCC countries are among those countries (Pinto 2018). This essay illustrates the concept of
currency pegging along with the GCC countries pegging their currency to U.S. dollar. It also
explains the advantages and disadvantages of currencies of GCC pegged to the U.S. dollar.
Discussion
As highlighted by Momani (2016), majority of the GCC countries have pegged their
currencies to the U.S. dollar for avoiding the risks of currency fluctuations and eliminating the
uncertainties in the international transactions. Among the countries, Kuwait has pegged its
currency to a basket of currencies which are dominated by the U.S. dollar. However, this facility

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comes at the cost of the flexibility of the monetary policy. Fixed exchange rate and a stable
domestic currency imply no currency risk, which encourages more investment and trade
facilitation. As oil is the primary commodity in the GCC economies and the oil price is fixed in
U.S. dollars, hence, any fluctuation in the exchange rate could lead to a drastic fall in the revenue
if the currencies were not pegged (Omair 2018).
There are quite a few advantages and disadvantages of currency pegging, which are well
experienced by the GCC countries over the years. These countries pegged their currencies to
U.S. dollar, which is not only one of the most stable currencies of the world but also the world’s
reserve currency, in order to have a steady or fixed exchange rate, which is beneficial for
building stable trade relations (Costigan, Cottle and Keys 2017).
The advantages of GCC pegging currencies against the USD are as follows:
Pegging of currency to the U.S. dollar helped the GCC countries to endure the shocks of
the subprime crisis, slowdown of the international markets and falling demand for oil. The GCC
countries got immense macroeconomic and financial stability during the period of global
financial crisis due to currency pegging (Sayed 2016).
As stated by Mosteanu (2017), IMF has instructed the GCC countries to reduce their
deficits and restore the growth momentum of the economy for maintaining the currency pegs to
the USD. This is an advantage for the economies as the governments will feel motivated to take
measures for economic growth. The currency pegging of the GCC against the USD has resulted
in fast-moving, flexible and dynamic economic growth as stability and certainty of the USD as
the reserve currency implies efficient economic and financial operations such as business and

3MONETARY POLICY AND EXCHANGE RATES
banking. It also provides a financial security and continuity during the diversification of
businesses.
According to Fischer (2015), de-pegging of the GCC currencies from the USD might lead
to a rapid and extreme devaluation of the GCC currency values. For example, when Kazakhstan
de-pegged its currency, Tenge, and floated in the free and volatile currency market, its value
dropped by around 25% in a single day. Hence, pegging of currencies by the GCC countries
against the USD has a significant role in stabilizing the value of those currencies and promoting
risk free economic growth.
Disadvantages of pegging are:
Depegging results in the devaluation of regional currencies but it encourages the creation
of employment in the industries like real estate, tourism and manufacturing. However, in the
GCC countries the economic growth faced challenges like lower demand for the crude oil and a
high dependence on the revenues from oil.
Furthermore, due to the fixed exchange rate, when U.S. increases their rates of interest, it
directly affects the GCC currencies. Fixed exchange rates indicate a nominal exchange rate as
the GCC currencies are represented in terms of the USD. However, when the U.S. interest rate
increases, its currency value appreciates and both the nominal and real exchange rates with the
GCC currencies change. Appreciation of USD also increases the value for the GCC currencies,
which makes their export costlier and import cheaper, and refinancing and borrowing rates
increase too (Gervais, Schembri and Suchanek 2016).

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Conclusion
Thus, from the above discussion, it can be concluded that the GCC countries have
benefitted from their currency pegging against the USD. Due to the pegging, these countries
could avoid the risks and uncertainties in the currency values and economic growth following the
global economic fluctuations and could take improvement measures for their economies.
However, currency pegging reduces the freedom of the monetary policies of the GCC countries
which are heavily dependent on the oil trading, and this sometimes curtails the growth
opportunities for the GCC countries.

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References
Costigan, T., Cottle, D. and Keys, A., 2017. The US dollar as the global reserve currency:
implications for US hegemony. World Review of Political Economy, 8(1), pp.104-122.
Fischer, C., 2015. Determining global currency bloc equilibria.
Gervais, O., Schembri, L. and Suchanek, L., 2016. Current account dynamics, real exchange rate
adjustment, and the exchange rate regime in emerging-market economies. Journal of
Development Economics, 119, pp.86-99.
Momani, B., 2016. The Political Economy of Monetary Integration and Exchange Rate Regime
in the GCC. In Shifting Geo-Economic Power of the Gulf (pp. 39-54). Routledge.
Mosteanu, N.R., 2017. Currency pegged to a foreign currency-GCC and Europe models. The
Business & Management Review, 9(1), p.52.
Ng, W., 2017. Setting a Value for a Currency: Interest Rate, Bank Reserve Ratio, or Pegging to a
Basket of Currencies of Major Trading Partners.
Omair, F.M., 2018. Feasibility study on the implementation of a Unified Currency in the Gulf
Cooperation Council. Journal of Economics Bibliography, 5(2), pp.107-121.
Pinto, L., 2018. Sustaining the GCC Currency Pegs: The Need for Collaboration.
Sayed, H., 2016. The pros and cons of GCC currencies staying pegged to the US dollar.
Zawya.com [online] Available at:
https://www.zawya.com/mena/en/story/The_pros_and_cons_of_GCC_currencies_staying_pegge
d_to_the_US_dollar-ZAWYA20161219113535/ [Accessed on 2nd Aug 2019].