Finally, monetary union in sight as countries strike deal By JOINT REPORT | Sunday, July 28  2013 at  15:31

EAC member states will not get automatic membership to the monetary union, but must meet set targets before admission. PHOTO | FILE. 

The five East African Community countries have finally agreed on the Monetary Union Protocol, to be approved by heads of state in November, ending years of gruelling negotiations that exposed the deep nationalistic misgivings that continue to frustrate the quest for closer regional ties.

The approval of the protocol sets the stage for an eventual phasing out of all the national currencies and the establishment of a single regional legal tender.

The deal was struck in a meeting held in Arusha on July 16 by the EAC Sectoral Council on the Monetary Union.

The protocol will be implemented over a 10-year period, with a single currency to be launched at the last stage, which will culminate in the integration of member states’ financial markets. The document is now under consideration by the Council of Ministers before submission to the Heads of State Summit.

However, member states will not get automatic membership to the monetary union, but must meet set targets before admission, to avoid a situation where members whose macroeconomic indicators are inadequate join the union and trigger the kind of crisis currently plaguing the Eurozone.

The negotiators, made up of top government officials from Kenya, Burundi, Rwanda, Uganda and Tanzania, have been banking on the experiences of other blocs in crafting the protocol, borrowing heavily from the EU model.

The creation of the monetary union is the next step in the integration of the EAC after the adoption of a Common Market and a Customs Union.

A major prerequisite for the formation of the monetary union is the establishment of a regional central bank and guaranteeing the independence of central banks of member states.

Slow implementation

But even as the heads of state prepare to append their signatures to the protocol, reservations persist on whether the monetary union will fly, given the slow implementation of the EAC Common Market Protocol as well as the tight macroeconomic parameters that the member states will be required to observe.

The EAC Common Market Protocol provides for the free movement of capital and labour, but regional countries have been slow in opening up their markets, with some still requiring citizens from neighbouring countries to pay for work permits before they are allowed to work.

This, analysts said, is denying the region larger markets, economies of scale, and promotion of local, regional, and global trade — the benefits envisaged from free trade among the member states.

This unsatisfactory state of affairs is blamed on the absence of a legally binding framework that has left businesses at the mercy of individual countries.

While in principle, the countries have agreed on elimination of non-tariff barriers (NTBs) like weighbridges, roadblocks, poor infrastructure, unnecessary delays at border posts, and lack of harmonised import and export standards, procedures and documentation — they are yet to act on many of these fronts.

The Common Market is also being held back by fear of losing tax revenue, continued existence of different rates of domestic taxes and multiple memberships in other regional economic blocs.

“At the moment, I have my reservations; I don’t believe the monetary union will be implemented in the next 20 years,” said Kassim Omar, chairperson of the Uganda Freight Forwarders Association, citing the slow implementation of the Common Market Protocol.

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

They 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 sustain their debt to GDP ratio at not more than half, and a tax to GDP ratio of 25 per cent to qualify to join the monetary union.

“Countries will have seven years to meet these targets, but must meet them consistently for three years before they can join the common currency,” said Richard Sindiga, Director of Economic Affairs at Kenya’s Ministry of the EAC.

It is these requirements that economists and experts say will pose the greatest challenge to member states, given their current macroeconomic indicators and high dependence on donor funding.

For example, donors fund about 40 per cent of Rwanda’s budget. They also fund about half of Burundi’s, with the country only able to raise $264 million in revenues. And even for Kenya, which is less dependent on donor funding, the country’s current fiscal deficit stands at around 11 per cent.

“Due to the large external grant inflows, EAC countries will find it difficult to meet these objectives… for example, if a country achieves an overall deficit close to three per cent of GDP, while at the same time receiving and spending grants in excess of three per cent, then the second objective (excluding grants) will be breached,” said the International Monetary Fund in its latest technical paper on the proposed monetary union.

There has also been a steep rise in debt among the countries, a factor that could pose a challenge to them as they move to comply with the requirement to maintain debt to GDP ratios of less than 50 per cent.

Though only Kenya and Tanzania — at around 45 per cent — are anywhere close to the limit, other countries continue to register a significant rise 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.

Rising debt levels

Kenya’s debt level has doubled from Ksh759 billion ($8.9 billion) in 2008, to Ksh1.5 trillion ($17.6 billion) as at the end last year, while Rwanda’s local debt rose from Rwf179 billion ($282 million) in 2011, to Rwf303.7 billion ($477 million). Rwanda’s total debt stands at Rwf899 billion ($1.4 billion).

Analysts say that although countries like Rwanda, Burundi and Uganda are well under the limit, some could be struggling to repay their debts.

In an economic update released in February, the IMF said Burundi faces a high risk of debt distress, though its debt to GDP ratio is only 24 per cent.

“Given the high risk of debt distress and the vulnerabilities, staff encourage the authorities to continue to rely on grants and highly concessional loans to meet financing needs,” said the IMF.

Analysts also see the requirement that countries maintain core and headline inflation at five per cent and eight per cent respectively, as a challenge, considering that as net importers, East Africa’s economies are susceptible to externally-induced inflation caused by factors like changes in oil prices.

For example, when the world price of coffee, which accounts for about 70 per cent of Burundi’s export earnings, dropped by 30 per cent in 2011, the reduced earnings negatively impacted the local unit, inducing inflation.

A combination of the deprecating local unit and other factors saw headline inflation peak at 25 per cent, though it has since declined to 8.2 per cent — which is still above the set threshold of 8 per cent.

But the problem is not confined to Burundi. Kenya’s inflation soared to a high of 20 per cent in 2011, partly as a result of external shocks, including a spike in oil prices. The figure has since come down to less than five per cent, though the country’s central bank notes that international oil prices as well as the economic happenings in the Eurozone still pose a challenge.

“Having a single currency is likely to reduce fluctuations of exchange rates that are usually a big problem for smaller economies like Rwanda and Burundi,” said Sirili Akko, executive officer at Tanzania Association of Tour Operators. “This will lower transaction costs and enhance trade and investment in the monetary union,” Mr Akko added.

The search for a uniform exchange rate policy for the region has been tricky, due to volatile market forces that have prevented negotiators from setting a standard conversion rate.

Still, the EAC states will struggle to meet the tax to GDP ratio of 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.

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.

“Member states should harmonise their tax collection regimes, widen their tax nets as well as seal tax leakages to have any chance of meeting the target,” said Samuel Nyade.