East Africa Set For Historic Shift As States Adopt EU-Type Monetary Union Plan

East Africa Set For Historic Shift As States Adopt EU-Type Monetary Union Plan
The single currency can only be adopted by at least three countries

AFRICANGLOBE – With the signing of the East African Community Monetary Union Protocol, the five member countries start on a journey that will eventually see them operate a single currency, potentially transforming them into a strong single market with greatly enhanced clout in African and global trade but also exposing them to risk of stumbling from crisis to crippling crisis in the manner of the Eurozone.

Under the Protocol, whose signing ends nearly four years of haggling, Tanzania, Rwanda, Uganda, Burundi and Kenya will harmonise their economic and monetary policies for long-term growth.

Among the key indicators that the member countries must harmonise are inflation rates, the tax to GDP ratio, debt to GDP ratio and fiscal deficits.

In addition, the Protocol, to be rolled out over 10 years as the region undertakes the requisite institutional and economic reforms to support it, provides for the establishment of a regional central bank.

It is expected to progressively trim the monopoly of the national banking systems in charting monetary and fiscal policy, with most of the economic decisions currently being made at the national level by central banks being taken over by regional institutions.

Under Article 5 of the Protocol, member states will first have to fully implement the Customs Union and the Common Market Protocol before they can implement the Monetary Union.

They will also have to first harmonise and co-ordinate their fiscal, monetary and exchange policies, as well as phase out any outstanding central bank lending to their governments and public entities.

The member states must also first attain the set macroeconomic criteria and maintain them for at least three consecutive years before embarking on the monetary union. This entails: Capping core inflation at five per cent; fiscal deficits, excluding grants, of no more than six per cent of GDP and a minimum tax-to-GDP ratio of 25 per cent.

Once the prerequisites have been met, the member states must also meet the macroeconomic convergence criteria. This entails maintaining a ceiling on headline inflation of eight per cent, a ceiling on fiscal deficits, including grants, of three per cent of GDP, a ceiling on gross public debt of 50 per cent of GDP on net present value terms; and maintaining a reserve cover of four-and-a half months of imports.

The countries will only undertake to adopt a single currency after all the prerequisites and macroeconomic criteria have been met. The single currency can only be adopted by at least three countries.

“Upon adoption of the single currency, the Monetary Union shall commence,” reads the text of the protocol.

And, as the countries strive to achieve the set criteria, the EAC Heads of State Summit will establish an institution, to be known as the East African Monetary Institute, to prepare for the monetary union.

According to the Monetary Union Protocol, member states must maintain an inflation rate ceiling of eight per cent. Currently, all the countries are within this threshold, apart from Uganda.

The provision requiring that countries maintain core and headline inflation at five per cent and eight per cent respectively is seen as a challenge for the five economies considering that as net importers they are exposed to wild fluctuations of determinants of inflation such as global fuel prices.

Latest data shows that Tanzania’s inflation rate rose to 6.3 per cent in October from 6.1 per cent the previous month. Rwanda’s inflation rate remained unchanged at 5.1 per cent, the same rate as September. Uganda and Kenya’s inflation rates fell in October to 8.1 per cent and 7.6 per cent respectively.

The other key threshold that the five countries will have to meet is keeping the tax to GDP ratio at 25 per cent. Given their narrow tax bases, the different tax collection regimes and the fact that most of the region’s businesses are informal and thus do not pay tax, economists said the countries may find it difficult to meet this parameter.

Currently, Kenya has the highest tax to GDP ratio at about 23 per cent, Tanzania is at 18 per cent, while Uganda and Rwanda tie at 12.6 per cent.

Countries will also be expected to keep their fiscal deficit (including grants) at less than three per cent. Excluding grants, they should maintain it at six per cent. Countries will also be expected to keep their debt to GDP ratio at not more than half to qualify to join the monetary union.

All the EAC countries have been registering increasing debt levels, a situation that will poses a headache for them as they look to comply with the provisions of the protocol. Though only Kenya and Tanzania are anywhere close to the limit, other countries continue to register significant rises in their debt levels.

Tanzania has seen its debt to GDP ratio jump from 30 per cent in 2008, to 45 per cent as at the end of last year, according to latest data from the World Bank.

Kenya’s debt-to-GDP ratio, usually seen as a measure of the health of a country’s economy, now stands as 54.1 per cent of GDP, compared with 51.7 per cent in June.

Latest data by the Central Bank of Kenya shows that the country’s public debt increased by Ksh110 billion ($1.2 billion) to stand at Ksh2 trillion ($23.5 billion) at the end of August, up from Ksh1.8 trillion ($21.1 billion) in June.

The International Monetary Fund and the World Bank have been pushing for a lower debt-to-GDP ratio. The government’s strategy has been to keep the ratio below 45 per cent in the medium term, with a target of 43.9 per cent by June 2016.

Higher ratios increase the risk of defaulting on debt obligations in the event of economic and financial distress and could erode the country’s credit rating. But there are other fears over the overall reliance on the EU model of monetary integration for the EAC arrangement.

“The criteria are still based on the EU-type monetary integration, a model that I feel is bankrupt. Actually, the criteria they have put down, in my view, are unrealistic, and a recipe for ‘backdoor’ neo-liberalism — a quite inappropriate set of macro-targets,” said an economist in Kigali on condition of anonymity because he consults for the government.

The thinking behind the eventual transition to the use of a single currency across the region is to reduce the costs and risks of transacting business across the national boundaries of the partner states of the EAC.

The EAMU, its proponents say, will do away with the costs incurred currently while transacting in different currencies.

A trader travelling from Kenya through Uganda to Burundi and Rwanda, for example, will lose more than 20 per cent of the value of the initial currency while converting during stopovers in these countries.

“A single currency in the EAC will enhance trade competitiveness across the region as fears of loss that mainly results from foreign exchange conversion in each country will be eliminated. Our worry remains whether they will implement what they are putting on paper,” said Sebaggala Kigozi, the executive director at the Uganda Manufacturers Association.

Business executives, economists and technocrats expressed muted optimism over the immediate benefits expected from EAMU, arguing the project requires a large dose of political will to be fully operational.

Their caution arises from the delays and faltering commitment seen among the EAC economies in implementing the Common Market Protocol, which allows for free movement of labour, goods and services.

“The biggest risk is getting into a single currency before you achieve significant convergence in fiscal and monetary benchmarks. Without free movement of labour across the region, it will remain hard for traders to realise benefits from a single currency regime,” said Adam Mugume, the executive director for research at the Bank of Uganda (BoU).

 

By: Mwara Kimani