THE EAST AFRICA MONETARY UNION ATTAINABILITY.

The East African Community (EAC) has the historic opportunity to create a monetary union that will increase the size of the regional market and could potentially bring economic development, gains from regional integration and trade, and enhanced global competitiveness for the EAC. However,there are important fiscal considerations that must be resolved if a future East African Monetary Union (EAMU) is to maintain a strong and stable currency and effectively manage shocks that impact each member country differently.


The EAC was first attempted in 1967 and then collapsed in 1977 due to political differences between Kenya, Tanzania and Uganda. Negotiations for the current EAC began in 1993, the permanent tripartite was signed, and the East African Customs Union and common market protocol became operational in 2010.

The fast approaching deadline for the launch of the East African Monetary Union is June 2012 and EAC leaders have taken notice of the current turmoil in Europe. The EAC permanent secretary, Stergomena Bamwenda, mentioned that if the necessary conditions are not in place before 2012 then the EAC will not go forward with the single monetary union. However, the EAC has continued to accelerate integration toward a monetary union with the development of a task force to address policy gaps that have been highlighted by the euro-zone crisis.


 

Once a single currency is adopted, fiscal policy will be the main macroeconomic policy available to individual countries after giving up independent national monetary policy. Thus, fiscal management is especially important in the context of a monetary union. Furthermore, by establishing appropriate and transparent fiscal convergence criteria, the EAC countries can ensure a smoother transition to a monetary union and lay a strong foundation that establishes the rules needed to address departures from agreed-upon debt and deficit limits. There is a need for explicit fiscal convergence criteria to be adopted by the EAMU as prerequisites and ongoing commitments for a monetary union.


 Fiscal convergence criteria are essential in proceeding towards a monetary union, it is also important that fiscal deficit limits be realistic and in line with recent and current deficit levels. Additionally, the legitimate need of East African countries to borrow in order to meet investment and development goals cannot be ignored. It is recommendable  that the EAMU adopt a measure of fiscal deficits inclusive of grants to best account for realities of domestic revenue generation challenges and reliance on donor support in some countries.


Research on aid flows indicates that budget assistance can have significant and volatile effects on domestic liquidity. Recognizing that the East African countries receive foreign aid flows, including budget support, limiting discretion in spending of budget aid for member countries can help ensure that problems managing aid flows do not have negative economic consequences at the regional level. This is especially important considering the risk of exchange rate appreciation and inflation spillovers in the context of a monetary union,

in which countries effectively have a fixed exchange rate regime with each other.

To avert problems associated with countries surpassing agreed-upon deficit levels, I propose that an automatic tax be applied to member states that run excessive deficits. Furthermore to ensure that debt limits are enforced, I suggest that member states agree to special rules and processes to deal with countries that do not meet requirements. Independent surveillance and adjudication will be important in
this regard.

Financial development is also crucial for effective monetary policy, and an important aspect of that development is building a yield curve of long-term interest rates for government debt by issuing benchmark bonds on a regular schedule and promoting secondary-market trading. This allows private borrowers to access markets more easily, and Kenya has been implementing these policies with success over the past few years.

Once a yield curve is in place, it can also provide valuable information for monetary policymakers seeking to implement a forecast-based monetary policy framework. Long-term interest rates reflect
market participants’ forward-looking expectations of inflation and other macroeconomic factors, so monitoring the yield curve can alert policymakers to changes in expectations.

Through my empirical analysis of recent bond market data from Kenya indicates that the yield curve is beginning to have useful information content, and I recommend that the Central Bank of Kenya develop indexes of long-term interest rates and continue to explore ways that this data can aid in policy making. Other EAC countries may want to follow Kenya’s lead in laying foundations for better yield curves.

As countries consider alternative monetary policy frameworks to reserves targeting, forecasting inflation will be important for the conduct of monetary policy. Furthermore, once forecasts are developed, IT could be an effective framework in East Africa. My research shows, however, that international commodity prices and rainfall, factors over which central banks have no control, impact inflation in East Africa. As a result, if the region moves to IT, I recommend that a measure of core inflation be developed and that countries target core inflation.

Finally, the euro-area crisis highlights the importance of an independent central bank for the region that will guide monetary policy formulation and implementation. In addition, the central bank must enforce prudential financial regulations for the financial sector of member countries. The East Africa Central Bank is planned to be formed along the lines of European Central Bank (ECB). Thus, one must consider the institutional deficiencies of the ECB in order to avoid falling into the same trap that the ECB is currently in. A crucial gap in the euro area is what to do when there is a run on government bonds since the ECB does not have a mandate to intervene. Nor is there a crisis management facility, such as an enhanced European Monetary Fund. The fiscal crisis has spilled over to the banking sector, for which there is no central supervision or a central or federal deposit insurance mechanism. In sum, the current treaty for the East African Community, unlike the one for the current EU euro area, needs to spell out safety measures and a bailout plan in case of debt or other fiscal problems among members.

The formation of the monetary union is a challenge given the great imbalance in individual national economic strengths of the EAC countries. They must be prepared to give up a degree of sovereignty and to converge politically to avoid collapse. The ideal integration situation is where the countries in the union share common monetary and fiscal policies, a common pool of foreign exchange reserves, and a common monetary authority or central bank. Otherwise, trying to operate a single currency without social, economic and political integration is likely to fail as evidenced by eurozone crisis.

For the time being, the EAC is better off slowing down the integration process. The 2012 monetary union launch is only feasible if all of the macroeconomic convergence criteria are met and harmonization of all fiscal, financial and monetary policies is complete. Instead of rushing to move into a currency union, regional integration in the East African Community should focus more on trade expansion and infrastructure coordination. Whatever the EAC countries decide, the process of forming a single monetary union should be carefully considered given the ongoing turmoil in Europe and the EU’s failure to resolve the problem.

 Finally, the euro-area crisis highlights the importance of an independent central bank for the region that will guide monetary policy formulation and implementation. In addition, the central bank must enforce prudential financial regulations for the financial sector of member countries. The East Africa Central Bank is planned to be formed along the lines of European Central Bank (ECB). Thus, one must consider the institutional deficiencies of the ECB in order to avoid falling into the same trap that the ECB is currently in.

A crucial gap in the euro area is what to do when there is a run on government bonds since the ECB does not have a mandate to intervene. Nor is there a crisis management facility, such as an enhanced European Monetary Fund. The fiscal crisis has spilled over to the banking sector, for which there is no central supervision or a central or federal deposit insurance mechanism. In sum, the current treaty for the East African Community, unlike the one for the current EU euro area, needs to spell out safety measures and a bailout plan in case of debt or other fiscal problems among members.

The formation of the monetary union is a challenge given the great imbalance in individual national economic strengths of the EAC countries. They must be prepared to give up a degree of sovereignty and to converge politically to avoid collapse. The ideal integration situation is where the countries in the union share common: 1) Monetary and fiscal policies.

2) Pool of foreign exchange reserves.

3) Monetary authority or central bank. 

Otherwise, trying to operate a single currency without social, economic and political integration is likely to fail as evidenced by euro-zone crisis.

For the time being, the EAC is better off slowing down the integration process. The 2012 monetary union launch is only feasible if all of the macroeconomic convergence criteria are met and harmonization of all fiscal, financial and monetary policies is complete. Instead of rushing to move into a currency union, regional integration in the East African Community should focus more on trade expansion and infrastructure coordination. Whatever the EAC countries decide, the process of forming a single monetary union should be carefully considered given the ongoing turmoil in Europe and the EU’s failure to resolve the problem.

Author Murigi Benson.