Typically,
the topics in the business section of a newspaper in the GCC will almost always
focus on issues such as the budget, deficits, subsidies, investment, etc. Meanwhile,
a publication in the United States will dedicate more time towards speculating on
the Fed’s imminent actions. Global financial markets gyrate to every move made
by the Fed and hence are constantly trying to guess what its next one is likely
to be. The GCC spends most of its time on fiscal issues since it has
effectively outsourced its monetary policy responsibilities to the US Federal
Reserve and therefore they are compelled to mirror the Fed’s policies
regardless of its domestic economic underpinning. Fortunately, for most part of
the arrangement, this worked reasonably well with business and economic cycles
of the US and GCC being roughly synchronized. Additionally, strong oil prices throughout
much of this period enabled GCC governments to build reasonable reserves; which
also thwarted any occasional challenges which would pressurize the pegged
currencies.
However,
the recent drastic fall in oil prices and oil revenues (on which the budgets
are heavily dependent) and the near unanimous consensus of the new low oil
price reality going forward has changed that scenario. Given the high and
growing break-even oil price (the oil price required to balance the budgets),
GCC governments will now either have to draw down on their reserves at a faster
rate or resort to borrowings to fill the gap. Being modeled as welfare
economies, the restructuring process to rationalize subsidies and stop
providing pseudo-employment in the public sector can be painfully slow. Hence,
GCC governments will focus on reducing their role as the main investor in their
respective markets and dedicate resources towards diversification strategies. The
private sector will be encouraged to play a larger role in this diversification
effort, especially in sectors such as healthcare, education and transportation
where the government is currently forced to commit significant funds and
capital. Also, research and innovation will rightfully be granted a higher priority
as it can quicken the transition from public to private sector-based economies.
As the shift happens, maintaining a
positive business environment will take precedence over government expenditure.
Improvements in ease of doing business ranking will have to be achieved in swift
time as the economy faces liquidity shortfalls, increase in cost of capital and
higher risk premium.
In such a
scenario, where government spending and employment will reduce and private
sector led diversification process takes center stage, an outsourced monetary
policy model may be counterproductive and costly. The ability to set short-term
interest rates in order to manage domestic cost of capital and inflation will
become important in order to orchestrate the transition. Monetary policy independence
would be a necessary requirement for this to be possible. Otherwise, a pegged currency
dictated by US monetary policy, where the interest rate curve may be sloping
upward going forward, can create serious frictions in the GCC’s low economic growth environment.
GCC
monetary policy independence is also warranted in an environment where the Fed
is running out of ammunition. According to The Economist, in the 3 most recent US
recessions the Fed slashed rates by 675 bps, 550 bps and 512 bps respectively.
However, what is interesting to note is the time taken for rates to return back
to normal levels. The Fed took 2.5 years and 3 years to return to normalcy in
the first two recessions respectively. However in the most recent recession of
2008, it is 8 years and counting. Should another recession occurs, the Fed will
not have the necessary tools at its disposal. It is generally opined that
long-term problems which are enveloping in the global system like low economic
growth, deflationary concerns and lack of business confidence cannot be solved
using the Fed’s short-term monetary tools. For a variety of factors, sooner or
later, the Fed will lose its role as the financial market’s sole saviour. Such
factors include the fact that its short-term interest rates have already hit
rock bottom, an inability to move back to normal rates for a long stretch of
time and the long-term nature of many problems that the Fed do not have resources
to provide solutions with.
It is
therefore time for the GCC to have an independent monetary policy framework
like its fiscal policy framework. Such monetary independence will provide the GCC
with the ability to set short-term rates and help guide the capital allocation
process more cost effectively. It will also enable better control of inflation
and will reduce friction in a challenging low growth economic environment.
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