External Stability Under Alternative Nominal Exchange Rate Anchors: An Application to the GCC Countries

The GCC countries' currencies are effectively pegged to the U.S. dollar (Appendix I).2 The exchange rate of the dollar with the other four major currencies that make up the SDR (German mark, Japanese yen, French franc, and British pound sterling) has been less stable than the exchange rate of the SDR with those currencies (Chart l).3 The fluctuations in the value of the dollar produce a significant degree of instability in the GCC countries' cross-exchange rates with the other SDR currencies. In view of the large share of the other SDR zone countries in the GCC countries' imports and exports, this has evoked arguments in favor of changing the effective peg of the GCC currencies from the dollar to the more stable SDR (Table 5). Along with the sharp depreciation of the dollar in recent years, these arguments have also been motivated by the international arrangements concerning the denomination of oil export prices. Oil exports of the GCC countries are largely dollar denominated and, on average, such exports make up about 80 percent of the GCC countries' exports. However, the shares of the other SDR zone and the rest-of-the-world (ROW) in the GCC countries' total imports are large. The share of the dollar-denominated imports in total imports is smaller than the share of dollar-denominated exports in total exports. Consequently, fluctuations in the value of the dollar may create significant disparities between export earnings and import bill. This, in turn, may result in disparities between the budgetary revenues and expenditures since, on average, about 75 percent of revenues are derived from oil exports and expenditures have a large import component in the GCC countries. Therefore, fluctuations in the value of the dollar may result in budgetary instability that reflects external instability. Thus, it would seem that a case could be made for changing the effective peg of the GCC currencies from the dollar to the SDR or to some other basket of currencies. The main question that this paper addresses is whether changing the effective nominal currency peg from the dollar to the SDR or to another basket might indeed improve overall external stability in the GCC countries.4