Should a common currency in the EAC come to fruition, the trade will be fueled by a reduction, albeit limited, in transaction costs, the elimination of exchange rate risk and region-wide price harmonisation – all of which will undoubtedly be underpinned by policy incentives.
- Monetary Union is the third stage towards EAC regional integration, capped through Political Federation.
- Considering individual economies are relatively small, currency harmonisation might play a significant role in improving intra-African trade.
- The IMF, through its chief Christine Lagarde, previously warned the EAC not to rush into a currency union, pointing to the issues faced in Europe.
Interest in regional integration, including monetary, in Africa has remained intense over the decades since independence. Consequently, various regional groupings have been formed. Those initiatives were stimulated by the generally small size of individual economies. This led to a desire to promote economies of scale in production and distribution. A common currency for Africa is a long-term goal of the African Union.
Africa’s Intra-regional trade stands at just 15 per cent. Thus, the limited size of intra-regional trade is one of the major factors impeding Africa’s economic growth over the years. Considering individual economies are relatively small, currency harmonisation might play a significant role in improving intra-African trade.
East African Community (EAC), comprised of seven nations, has proposed a common currency. The trade bloc has also approved plans to harmonise monetary and fiscal policies to establish a regional central bank. Thus, the prospect of a common currency in the EAC remains a reality.
Prospective benefits of a common currency in the EAC
Monetary Union is the third stage towards EAC regional integration, capped through Political Federation. EAC member states have already been working toward comprehensive Customs Union and Common Market membership, despite several hurdles, including non-tariff barriers, trade blockades, and border point closures. Early evidence suggests the EAC will avoid blurring national lines to encourage financial growth.
Should a common currency in the EAC come to fruition, the trade will be fueled by a reduction, albeit limited, in transaction costs, the elimination of exchange rate risk and region-wide price harmonisation – all of which will undoubtedly be underpinned by policy incentives.
Amidst the incredible optimism and promise of economic development through greater integration and bilateral trade following a common currency in the EAC, the fact that cross-border flows will be made more accessible and more efficient following a currency union has seldom been mentioned.
Capital flow in the EAC
However, the unrestricted flow of capital, both regional and, more pertinently, foreign remittance in finance, will undoubtedly continue playing a vital role in helping to sustain and drive development in the region.
It is correct to suggest that the EAC, home to approximately 283 million people and a new frontier mineral exploitation through the recent entry of DR Congo, will attract more significant levels of foreign direct investment (FDI). A common currency through the monetary union would build on these gains.
In general, for countries within the EAC to benefit from a monetary union, they should meet the criteria for mitigating the effects of asymmetric shocks. Countries should exhibit flexibility in prices and wages. Economies must also have high interregional factor mobility and a high degree of openness. This allows the absorption of shocks without necessarily adjusting the nominal exchange rate.
Moreover, a high degree of product diversification helps to overcome industry-specific shocks. A high degree of fiscal integration helps to contain the impact of asymmetric shocks through fiscal transfers between countries. There should also be a convergence of inflation rates to avoid causing variations in terms of trade.
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The common currency roll-out needs a cautious approach
Among the hurdles that hindered the euro were barriers to the movement of labour and capital within a diverse region like Europe. More importantly, the Eurozone economies were effectively running on different cycles at contrasting stages of growth.
These issues would not be so apparent in the EAC. Except for Burundi, other EAC member countries have a similar GDP per capita, despite Kenya being the largest EAC economy.
Equally, the EAC is already an established trade bloc with a common market for goods, labour and capital within the region. As a result, many foundations are already set towards implementing an East Africa Monetary Union. This includes harmonising banking regulation and payment system integration and harmonising monetary and exchange-rate policy formulation and implementation. Furthermore, there is strong political support for a common currency in the EAC, which remains critical.
The prevailing challenges
Encouraging as these developments are, the IMF was undoubtedly 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 becomes operational.
The EAC has set 2024 as the target year for achieving the Monetary Union. However, a 2020 report by United Nations Economic Commission for Africa pointed out that divergences in monetary policies continue to stand in the way of attaining a common currency.
Consequently, the institutions and support structures established to support the common currency in the EAC, including a regional central bank and a statistics body, effectively take away national autonomy in steering monetary policy.
Furthermore, a new regional central bank will assume responsibility for setting a standard interest rate for the entire region. However, the interest rate set by the central bank may be inappropriate for countries growing much faster or much slower than the EAC average.
For example, in response to the rising inflation levels in 2022, the Bank of Uganda raised its benchmark rate to 10 per cent and influenced commercial banks to do the same with their interest rates. Meanwhile, Kenya’s policymakers felt that an 8 per cent interest rate was suitable for delivering the desired price stability.
How the EAC manages the fiscal convergence criteria will be vital to plans for the common currency, particularly given the heavy dependence on aid flows to mitigate fiscal imbalances – although the degree of dependence on aid differs among the EAC countries.
The progress so far
In June this year, the first Deputy Prime Minister and Minister for EAC affairs, Rebecca Kadaga, reiterated that the region was on course to deliver a common currency by 2024. During the Uganda-DR Congo Business Summit in Kinshasa, Ms Kadaga said member states were working on the finer details to choose the host country for the East African Monetary Institute that will later transition into East Africa Central Bank.
The EAC has seven member states, including Uganda, Tanzania, Kenya, Rwanda, Burundi, South Sudan and DR Congo. However, only four from DR Congo have ratified the Single Currency Protocol. South Sudan remains an observer state. The country has not yet harmonised internal laws and still has laws that prevent the free movement of people.
Unprecedented delay for a common currency in the EAC
The EAC may not attain the single currency per the agreed timeframe of 2024. A technical working group of the EAC member countries’ finance ministries has proposed delaying the adoption of a common currency until 2031.
Dr Peter Mathuki, the EAC secretary general, confirmed the developments in late November. Dr Mathuki confirmed that the working group had submitted the proposal to the EAC Council to review the report. The council is poised to pass a resolution to establish an East African Monetary Institute. The institute represents a roadmap towards a common currency in the EAC.
The EAC council has a timeline to meet before the year ends to consider the proposals. According to the review undertaken by the EAC secretariat in Arusha, the customs union and common market procedures have not yet attained full implementation. The inability to apply the two protocols led to the failure to achieve the third pillar, a monetary union, the primary manifestation of which is a common currency in the EAC.
All member countries should have met the macroeconomic convergence requirements by 2021 to achieve a common currency in the EAC. The requirements include headline inflation of 8 per cent, the gross public debt of 50 per cent of GDP, 4.5 months of import cover, and a cumulative deficit of no more than 3 per cent of GDP, including grants. However, Kenya, Rwanda, and Burundi have surpassed their debt ceilings. This has prompted a request for an extension of the Monetary Union deadline.
The East African Legislative Assembly (EALS) has passed legislation establishing the East African Monetary Institute, the East African Statistics Bureau, the East African Surveillance, Compliance, and Enforcement Commission, and the East African Financial Services Commission. All these institutions and frameworks have the same goal towards implementing a common currency in the EAC.
