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The pros and cons of EAC monetary union

The pros and cons of EAC monetary union

Proceed with caution
Although the beleaguered IMF chief Christine Lagarde recently warned the bloc not to rush into a currency union, pointing to the issues faced in Europe while implying that the convergence benchmarks were slightly too ambitious, the EAC is already better positioned than the Eurozone countries were back in 1999 to form such a union. This is due to the close economic, political and even social ties which already exist between the East African countries.

Among the hurdles that hindered the euro were barriers to the movement of labour and capital within a diverse region like Europe, and, more pertinently, the fact that the Eurozone economies were effectively running on different cycles, at contrasting stages of growth.

These issues would not be so apparent in the EAC. With the exception of Burundi, the five EAC member countries have a similar GDP per capita, despite Kenya being the largest EAC economy.

Equally, the EAC is already an existing trade bloc with its own common market for goods, labour and capital within the region. As a result, many of the foundations have already been laid towards the implementation of an East Africa Monetary Union, including the harmonisation of banking regulation and the payment system integration, the harmonisation of monetary and exchange-rate policy formulation and implementation. Furthermore, there is strong political support for a single currency, which is critical.

The EAC, home to approximately 135m people, and a new frontier for oil and gas exploration, will attract greater levels of foreign investment on the back of a monetary union

Encouraging as these developments are, Ms Lagarde is certainly correct to warn of the need for caution: there are serious considerations which will prove challenging for the EAC if, or indeed when, the monetary union is introduced.

For example, the institutions and support structures which will have to be established to support the single currency, including a regional central bank and a statistics body, effectively take away national autonomy in steering monetary policy.

Secondly, a new central bank for the region will assume responsibility for setting a common interest rate for the entire East African Community. However, the interest rate set by the central bank may be inappropriate for countries which are growing much faster or much slower than the EAC average.

For example, Uganda experienced high inflation levels in 2011 that resulted in the Bank of Uganda raising its base rate and influencing commercial banks to do the same with their interest rates. Meanwhile, Kenya’s policy makers felt that interest rates approximately 8 to 10% lower than those of Uganda, were suitable for delivering the desired price stability.

How the EAC manages the fiscal convergence criteria will be vital to plans for a monetary union, particularly given the heavy dependence on aid flows to mitigate fiscal imbalances – although the degree of dependence on aid is different among the EAC countries.

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Written by African Business Magazine

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