Common Currency Area/ Optimum

currency area in Asia

Optimum currency area (OCA) is a geographical region in which it would maximize economic
efficiency to have the entire region share a single currency
A CCA may either have a single common currency or the member states may retain their individual
currencies but these must be rigidly pegged against one another
Economists are very skeptical about the benefits of a common currency. They say Euro was done
more on political than on economic considerations. Certain conditions must be fulfilled for a common
currency to be beneficial to all member countries that form a common currency area (CCA)
1. Labor mobility across the region.
2.Openness with capital mobility and price and wage flexibility across the region
3. A risk sharing system such as an automatic fiscal transfer mechanism to redistribute money to
areas/sectors which have been adversely affected by the first two characteristics
4.Participant countries have similar business cycles
Common currency more an outcome,
rather than a cause, of economic
integration
Principal reason commonly advanced for a CCA in Asia is that it would promote greater trade
and economic integration in the region by reducing transaction costs and exchange rate
uncertainty
Having a common currency does not necessarily promote greater economic integration, nor
does not having one prevent integration
Some of the most economically integrated countries, such as USA-Canada, Switzerland-EU and
Australia-New Zealand have separate currencies
Some Central American and Pacific Island countries use (or used) US dollar as their official
currency; but this did not greatly promote trade or economic integration with the USA or other
dollar countries
European countries did not become substantially more integrated post-1999 (when Euro was
accepted as a common currency) than they were before. In fact the common currency was
arguably more an outcome, rather than a cause, of economic integration
Pros & Cons
Pros Cons
Elimination of transaction costs related to trading
currencies; Do away with the need of maintaining forex
reserves; Do away with currency risk, benefiting foreign
investors


Loss of national monetary policy A single currency would
imply a single interest rate. Thus, a region or nation
experiencing economic depression will be unable to use
the interest rate lever to boost the economy. Similarly a
country with high inflation will be unable to independently
raise interest rates to contain inflation. Moreover, Islamic
countries, which form a large part of the geography, do
not believe in interest rates
Eliminate the chance of currency failure, which would
make foreign investment decisions much easier in
emerging economies; Such a currency would in one go
eliminate the problem of current account deficits as there
would be no need for foreign exchange


Political barriers Political differences between nations
make it extremely difficult for them to adopt a common
currency. It can lead to a loss in political sovereignty as
monetary interests would need to surpass political
interests. This is unlikely to be acceptable to most of the
nations and the idea of a single currency may be difficult
to implement
Implications of common currency
It will render individual monetary policies inoperable: a member country of a currency or monetary
union cannot have an independent monetary policy. Nor can it have any exchange rate policy. An
obvious corollary is that there will be no necessity for a central bank
Not having an independent monetary policy or currency may not always be undesirable. All those
countries that have adopted a common currency obviously thought so. The desirability of a common
currency sometimes arises from the incompetence (actual or suspected) of monetary authorities or
excessive pressure on them from politicians for the adoption of harmful monetary policies
The principal attraction of a stable common currency from an academic point of view is that it avoids
the credibility problem and thereby helps to anchor inflationary expectations.
This is highlighted by the recent economic crisis in Zimbabwe where inflation ran at a rate of over
hundreds of billion percent per year. As the Zimbabwean dollar became worthless, the government
was forced to officially permit the use of foreign currencies (US dollar, Botswana pula and South
African rand) in 2009 to stem the run-away hyperinflation. It fell to less than 3 percent by the end of
2012
Common currency in South Asia
The economic realities of South Asia are such that a common currency will in effect mean the
Indian Rupee (and Reserve Bank of India will be the de facto South Asian central bank)
This is suggested by the fact that Bhutan and Nepal already use Indian rupee alongside their
own currencies. Currently, Indian GDP is about 80 percent of South Asian GDP
It is inconceivable that Pakistan will join a monetary union with India in the foreseeable future
such that a South Asian monetary union can be established only by excluding Pakistan
In this event Indian share of the proposed unions GDP will rise above 90 percent. A currency
union will mean the abolition of the currencies and the central banks of all countries and the
formation of a South Asian central bank with a common currency
Each member country will perhaps have some representation in the central bank, but their
voice will be mute since, unlike SAARC, decisions will be made by the weight of the economy
Predicaments that may arise in a
monetary union in Asia
To visualize the predicaments that may arise in a monetary union, suppose that the Indian
economy is doing well its exports soaring, FDI flooding in and remittances rising. These would
imply a substantial improvement in the balance of payments of the union and hence a
strengthening of the common currency
Now further suppose that the Bangladesh economy is not doing as well; its export stagnant, FDI
minimal and remittances modest. Hence, GDP growth of Bangladesh falters and unemployment
rises
The normal policy response in such a situation in Bangladesh would be a monetary expansion to
reduce interest rates and a depreciation of the domestic currency. However, none of these is
feasible in the monetary union since neither money nor the exchange rate is controlled by
Bangladesh. The only option then is to resort to fiscal expansion
Common Currency
World had a common currency for most of its history; gold. The reason it worked fairly well is
because the production of gold is both decentralized and expensive
The reason a common paper currency wouldn't work is because the power would be
centralized and too easy to abuse. Whoever would control the world currency could set interest
rates, inflation rates, and influence who would get access to the currency sooner
The world is too diverse to group under one economic system. The efficiency gained from the
ease of a common currency wouldn't even come close to outweighing the negative distortionary
effects it would have

Creation of a monetary union without
a political union can be a disaster
Creation of a monetary union without a political union could be a recipe for disaster (Euro crisis
is a proof of that)
A monetary union (common currency) deprives uncompetitive areas of the ability to devalue
their currency and improve their competitiveness
This would not matter in a political union like present India, where funds flow automatically
from surplus states like Maharashtra via New Delhi to deficit states like Assam and Bihar
But India and Pakistan can never be a political union. So funds will not automatically flow from
India to Pakistan or vice versa
Asia is too diverse to group under one economic system. The efficiency gained from the ease of
a common currency wouldn't even come close to outweighing the negative distortionary effects
it would have