The GCC Monetary Union: Choice of Exchange Rate Regime

The creation of a monetary union has been the primary objective of the Gulf Cooperation Council (GCC) members since the early 1980s. Significant progress has already been made in regional economic integration: The GCC countries have largely unrestricted intraregional mobility of goods, labor, and capital; regulation of the banking sector is being harmonized; and in 2008 the countries established a common market. Further, most of the convergence criteria established for entry into a monetary union have already been achieved. In establishing a monetary union, however, the GCC countries must decide on the exchange rate regime for the single currency. The countries’ use of a US dollar peg as an external anchor for monetary policy has so far served them well, but rising inflation and differing economic cycles from the United States in recent years has raised the question of whether the dollar peg remains the best policy. Mohsin Khan considers the costs and benefits of alternative exchange rate regimes for the GCC. These include continued use of a dollar peg, a peg to a basket of currencies such as the SDR or simply the dollar and euro, a peg to the export price of oil, and a managed floating exchange rate. In light of the structural characteristics of the GCC countries, Khan considers the dollar peg the best option following the establishment of a GCC monetary union. The peg has proved credible and is easy to administer. If further international integration in trade, services, and asset markets makes a higher degree of exchange rate flexibility desirable in the future, implementing a basket peg could provide this flexibility. Regardless, the choice of exchange rate regime for the GCC countries need not be permanent: The countries could initially peg the single GCC currency to the US dollar and then move to a more flexible regime as their policy needs and institutions develop.Exchange rate regimes, monetary unions, Gulf Cooperation Council

The Design and Effects of Monetary Policy in Sub-Saharan African Countries

Since the 1990s there have been a number of major changes in the design and conduct of monetary policy. In a globalized environment, there is less time to adjust to shocks and greater need to achieve closer convergence of economic performance among trading partners. As a result, a number of developing countries have adopted exchange rate regimes with more flexibility, and thereby greater scope for monetary policy. Notable examples include a number of sub-Saharan African countries moving from fixed exchange-rate regimes to more flexible regimes and the adoption of formal or informal inflation targeting regimes by some of these countries. These changes have triggered considerable debate on how monetary policy should be conducted and the effects it has on the real economy. Mohsin Khan discusses the conventional objectives, targets, and instruments of monetary policy, including an analysis of the monetary transmission process. This paper examines the problems of dynamic inconsistency and inflationary bias, where governments deviate from their stated or target inflation level in order to obtain short-run output gains. Most economists now agree that any rules-based regime permits a margin for discretion, and they reject the idea that rules and discretion are mutually exclusive. As policymakers in many countries throughout the world have gravitated toward an approach based more on rules than on full discretion, a key issue is choosing an appropriate policy target, or nominal anchor. Khan discusses nominal anchors and current monetary frameworks before moving on to analyze the output effects of monetary policy. He looks at the relationship between the growth of GDP and different monetary aggregates in 20 sub-Saharan African economies and finds empirical support for the hypothesis that credit growth is more closely linked than is money growth to the growth of real GDP in these countries.Monetary policy, Africa

Human Capital and Economic Growth in Pakistan

Pakistan’s economy has grown faster on average than many other low- and middleincome countries over the past two decades. But several countries in Southeast Asia have fared even better. This paper focuses on factors that explain Pakistan’s relative growth performance. In addition to more traditional factors believed to determine growth, this paper looks particularly at the role of differences in the quality of human capital. The cross-country empirical results suggest that accumulation of physical capital and improvements in the quality of institutions have the largest pay-offs in terms of achieving higher growth, but that better education and health care also have a significant impact. Investment in these areas will increase the possibility of Pakistan entering a virtuous cycle of high growth and improved living conditions for the population.

India-Pakistan Trade: A Roadmap for Enhancing Economic Relations

Periodic heightened political tensions between India and Pakistan have derailed attempts to improve economic ties and trade relations between the two countries. India-Pakistan trade is unnaturally small, currently about $2 billion per year. Pakistan accounts for less than 1 percent of India's trade, and India accounts for less than 5 percent of Pakistan's trade. Constraints include high tariff and nontarrif barriers, inadequate infrastructure, bureaucratic inertia, excessive red tape, and direct political opposition. Khan recommends that President Asif Ali Zardari and Prime Minister Manmohan Singh, who had their first post-Mumbai attacks meeting on June 16, and are slated to meet again in Egypt in July, should pick up from where former President Pervez Musharraf and Prime Minister Singh left off in their meeting in New Delhi in April 2005. The two governments could start with implementing short-term measures mainly to facilitate trade--such as easing restrictions on visas, opening additional border crossings and road routes, and increasing air links--many of which have already been agreed in principle at the April 2005 Musharraf-Singh meeting. The success of these "confidence building" short-term measures and the resulting growth in trade would encourage the creation of constituencies that would support more far-reaching liberalization of trade between the two countries. Over the medium to long term, Pakistan should grant most favored nation (MFN) status to India, which India already provides to Pakistan, and allow transit trade from India; India should significantly lower tariff rates for goods of particular interest to Pakistan (e.g., textiles) and remove nontariff barriers; and both countries should facilitate trade in energy, information technology, and services, remove obstacles to foreign direct investment flows, and harmonize customs procedures. Improving economic ties may help to resolve the larger political issues that have bedeviled India-Pakistan overall relations for over 60 years.

Government Investment and Economic Growth in the Developing World

There has been a sea change in the views of the economics profession as well as economic policy-makers over the past decade or so regarding the role of the government in the development process. Indeed, it is now becoming conventional wisdom that government can no longer be a dominant player in economic activities, but rather should restrict itself to providing an “enabling” environment within which the private sector can take the lead and flourish. More specifically, government intervention in the economy has to be designed carefully so as to support the private sector and not inhibit its development. The general acceptance of this paradigm is evident in the steadily declining importance of government activities in the economies of most of the developing world. But does this new paradigm mean that government investment has no role whatsoever in affecting growth in developing countries? Reality is that public investment still represents a large share of total investment in the majority of developing countries, and the question is what role it plays in relation to private investment in stimulating economic growth. The objective of this paper is to ascertain empirically for a large group of developing countries the relative importance of public and private investment in promoting and sustaining growth.

Agricultural Growth in China and Sub-Saharan African Countries

Agriculture remains a dominant sector in the economies of most African and several Asian countries. However, the poor performance of agriculture in Africa stands in sharp contrast to the robust agricultural growth in many Asian countries.2 In this regard, the experience of China is perhaps as impressive as it is relevant to many countries in Sub-Saharan Africa. A general observation is that the productivity of land and labour has to rise through intensive agriculture, given the limited area of arable land (in China and Africa) and the high rates of growth of population (as in Africa). In many African countries, labour productivity has fallen and land productivity has not increased significantly. In China, productivities of both land and labour have increased significantly since at least the early 1980s. Agricultural output can increase in three ways: (i) get more from the same quantities of inputs through better utilisation of the existing capacity; (ii) use increased quantities of inputs; and (iii) use new techniques to raise the productivity of each input or raise the total product curve. All of these may require changes in tenurial arrangements, levels of investment in infrastructure and support services, and policies that affect the prices of outputs and inputs. A close examination of factors underlying the contrasting experiences in China and African countries reveals important differences in the institutional and policy environments affecting the individual behaviour with regard to the adoption and use of new (profitable) technologies to raise the land and labour productivities.

Interest Rate Determination in Developing Countries: A Conceptual Framework

As a number of developing countries move towards more liberalized financial systems, the question of how interest rates respond to foreign influences and domestic policies is one that policymakers in these countries have started to face. Most existing studies of interest rates typically treat only the extreme cases of either a fully open economy, where some form of interest rate arbitrage holds, or a completely closed economy, in which interest rates are determined solely by domestic monetary factors. Developing countries, however, generally fall somewhere between these two extremes, so that the standard models of interest rate determination would not seem to be relevant to their case.The purpose of this paper is to outline a theoretical framework that can serve as a starting point for analyzing interest rate determination in those developing countries that are in the process of removing controls on the financial sector and restrictions on capital flows. The approach suggested here combines elements of the closed-economy and open-economy models, and thus is able to incorporate the influences of foreign interest rates, expected changes in exchange rates, and monetary developments on domestic interest rates. An interesting feature of the resulting model is that the approximate degree of financial openness, defined as the extent to which domestic interest rates are linked to foreign interest rates, can in fact be as certained from the data of the particular country. To illustrate the empirical validity of the proposed model it was applied to two countries -- Colombia and Singapore. These two countries are quite different in terms of levels of financial development and degrees of openness, and thus provide a useful first test of the general nature of the model. The model is able to represent both these cases quite adequately. The estimates indicate that in Colombia both foreign and domestic factors are important, while domestic interest rates in Singapore are fully determined by foreign interest rates and variations in the exchange rate. This is precisely what would have been expected, given the characteristics of the respective financial systems in the two countries.

Real Exchange Rates in Developing Countries: Are Balassa-Samuelson Effects Present?

There is surprisingly little empirical research on whether Balassa-Samuelson effects can explain the long-run behavior of real exchange rates in developing countries. This paper presents new evidence on this issue based on a panel-data sample of 16 developing countries. The paper finds that the traded-nontraded productivity differential is a significant determinant of the relative price of nontraded goods, and the relative price in turn exerts a significant effect on the real exchange rate. The terms of trade also influence the real exchange rate. These results provide strong verification of Balassa-Samuelson effects for developing countries. Copyright 2005, International Monetary Fund

Asia and Global Financial Governance

Currently, Asia’s influence in global financial governance is not consistent with its weight in the world economy. This paper examines the role of Asia in the International Monetary Fund (IMF) and the Group of Twenty (G-20). It looks in particular at how the relationship between East Asian countries and the IMF has evolved since the Asian financial crisis of 1997-98 and outlines how Asian regional arrangements for crisis financing and economic surveillance could constructively interact with the IMF in the future. It also considers ways to enhance the effectiveness of Asian countries in the G-20 process.Asia, G-20, IMF, regional financial arrangements, global governance

The Exchange Rate and Consumer Prices in Pakistan: Is Rupee Devaluation In Inflationary?

This paper challenges the popular view that devaluation of the rupee is inflationary. Recent developments in the theoretical literature are reviewed to explain why consumer prices would be unresponsive to exchange rate changes in the short run. Then empirical tests are conducted for Pakistan during the period 1982 to 2001 to examine whether inflation is systematically related to changes in the exchange rate. The empirical analysis finds no association between rupee devaluations and inflation in Pakistan. It appears, therefore, that concerns about the inflationary consequences of rupee devaluation are unsupported by the facts