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The Quest for Regional Integration in the East African Community

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The Quest for Regional Integration in the East African Community The Quest for Regional Integration in the East African Community EDITORS Paulo Drummond, S. Kal Wajid, and Oral Williams INTERNATIONAL MONETARY FUND ©International Monetary Fund. Not for Redistribution © 2014 International Monetary Fund Cover design: IMF Multimedia Services Division Cataloging-in-Publication Data Joint Bank-Fund Library The East African Community : quest for regional integration / editors: Paulo Drummond, Kal Wajid, and Oral Williams. – Washington, D.C. : International Monetary Fund, [2014]. p. ; cm. Includes bibliographical references and index. ISBN: 978-1-48436-441-3 (Paper) 1. East African Community. 2. Africa, East – Economic integration. 3. Monetary unions – Africa, East. 4. Customs unions – Africa, East. 6. Social integration – Africa, East. I. Drummond, Paulo Flavio Nacif, 1966- II. Wajid, Syed Khalid S. III. Williams, Oral. IV. International Monetary Fund. HG1342.E32 2014 Disclaimer: The views expressed in this book are those of the authors and do not necessarily represent the views of the International Monetary Fund, its Executive Board, or management. Please send orders to: International Monetary Fund, Publication Services P.O. Box 92780, Washington, DC 20090, U.S.A. Tel.: (202) 623-7430 Fax: (202) 623-7201 E-mail: [email protected] Internet: www.elibrary.imf.org www.imfbookstore.org ©International Monetary Fund. Not for Redistribution Contents Foreword ........................................................................................................................................v 1 Overview ..........................................................................................................................1 Paulo Drummond, S. Kal Wajid, and Oral Williams 2 Sustaining Growth in the East African Community ....................................... 11 Catherine McAuliffe, Sweta C. Saxena, and Masafumi Yabara 3 Economic Convergence to Support the East African Monetary Union .......................................................................... 39 Nabil Ben Ltaifa, Masafumi Yabara, and Oral Williams 4 The Fiscal Policy Challenges of Monetary Union in East Africa ................. 61 Sanjeev Gupta and Jimmy McHugh 5 Implications of Monetary Union for National Fiscal Institutions in East Africa ............................................................................. 85 Richard Hughes 6 Building a Framework to Harmonize Monetary Policy ................................. 99 Armando Morales 7 How Strong Is the Monetary Transmission Mechanism in the East African Community? .................................................133 Hamid R. Davoodi, Shiv Dixit, and Gabor Pinter 8 Exchange Rate Arrangements in the Transition to East African Monetary Union ..........................................................................159 Christopher S. Adam, Pantaleo Kessy, Camillus Kombe, and Stephen A. O’Connell 9 Financial Sector Stability: A Regional Approach ...........................................199 Mary Zephirin and S. Kal Wajid 10 Cross-Country Financial Linkages and Implications for Financial Sector Supervision .................................................................................221 Etibar Jafarov iii ©International Monetary Fund. Not for Redistribution iv Contents 11 Financial Integration Ahead of East African Monetary Union ..................239 Masafumi Yabara 12 Themes and Lessons from the Financial Sector Assessment Programs ..............................................................................................263 S. Kal Wajid Contributors ............................................................................................................................287 Index ..........................................................................................................................................291 ©International Monetary Fund. Not for Redistribution Foreword The East African Community (EAC) is a unique regional entity that was estab- lished in 2000 with a clear road map for establishing a Customs Union, Common Market, Monetary Union, and, ultimately, a political federation. The EAC Customs Union Protocol came into force in 2005 and the implementation of the Common Market Protocol commenced in 2010. The EAC Monetary Union (EAMU) Protocol comes into force in 2014. These stages of integration are being implemented in a progressive manner and major strides are being made to estab- lish a political federation. The EAMU Protocol is a key milestone on the road to a single currency area in 2024 upon fulfilment of the key macroeconomic conver- gence targets. Economic integration is benefiting the East African people through increased efficiency and productivity, and the entry into a single currency will eliminate bilateral foreign exchange risk, reduce transactions and accounting costs for intra- regional trade, and foster financial integration. This will facilitate the expansion of regional trade and investment, which will promote economic growth and cross-border financial transactions, resulting in lower interest rates. This book is being produced at a time when critical economic reforms are being undertaken in fiscal, monetary, and exchange rate policies to achieve the EAC macroeconomic convergence criteria which are a major cornerstone in the EAC currency union arrangement. The book catalogs recent developments and presents ideas for the way forward on harmonization and coordination of fiscal, monetary, and financial policies, including strengthening and harmonizing the institutional framework underpinning these policies, as well as statistical harmo- nization and public financial management. It elaborates the framework for the formulation and implementation of monetary policy aimed at ensuring low and stable inflation and strong growth, discusses the alternative exchange rate arrange- ments in the transition to monetary union, and outlines the necessary regional financial stability framework. In doing so, it also draws on the different experi- ences of other currency unions. The path to single currency will go hand in hand with sustainable and robust economic growth and undertaking the necessary investments in infrastructure. The EAC region has had recent discoveries in oil and natural gas, which, if well utilized through an EAC-wide coordinated revenue management framework complemented with robust macroeconomic policies, will raise the standard of living of the East African people. I appreciate the commitment of the authors in producing this book, which is an important contribution toward establishing a robust macroeconomic framework for the EAC region. Ambassador Dr. Richard Sezibera Secretary General East African Community ©International Monetary Fund. Not for Redistribution This page intentionally left blank ©International Monetary Fund. Not for Redistribution CHAPTER 1 Overview PAULO DRUMMOND, S. KAL WAJID, AND ORAL WILLIAMS Under the Treaty for the Establishment of the East African Community (EAC), the signatory nations—Burundi, Kenya, Rwanda, Tanzania, and Uganda—have committed to regional integration across economic, social, and political spheres. The treaty explicitly emphasizes political federation as the ultimate goal under- pinning regional integration efforts, which led to the ratification of the Customs Union Protocol in 2005 and the Common Market Protocol in 2010. Efforts toward a monetary union are well advanced and the member countries have adopted a Monetary Union Protocol. Historically, countries in East Africa have at different times coalesced around forming some form of a currency union. In 1905 a currency board was estab- lished, creating a common currency for the East Africa Protectorate (which became the British colony of Kenya in 1922) and the Uganda Protectorate. Tanganyika joined after the First World War. A new currency board was consti- tuted in 1919 by countries under British rule (Kenya, Uganda, and Tanganyika and, in 1936, Zanzibar) that adopted the East Africa shilling. The Blumenthal Report in 1963 recommended separate central banks, and an IMF mission in 1965 provided assistance with the introduction of a common currency and an East African Central Bank. After independence, local currencies were fully and freely convertible into sterling, and in 1966 the common currency became fully convertible legal tender in Kenya, Uganda, and Tanzania. The depreciation of sterling in the late 1960s and early 1970s led to the disintegration of the Sterling Area in 1972.1 Following a period of divergence of inflation targets and interest rates, the East African Currency Area was formally ended in 1977. The recent efforts toward a monetary union therefore build on a long and fascinating history of monetary arrangements in the region. This book focuses on regional integration in the EAC. It is motivated by on going initiatives in this direction that have significant sway over economic policymaking and economic outcomes in the region. The EAC countries are also among the fastest growing economies in sub-Saharan Africa since 2000 and have achieved average per capita income growth higher than that region. The EAC 1 When the United Kingdom left the gold standard in 1931, many countries that had pegged their currencies to gold pegged them to sterling instead. After devaluation of the pound sterling in 1967, many countries in the sterling area did not also devalue, despite the imposition of exchange controls to minimize flight from sterling to the U.S. dollar. 1 ©International Monetary Fund. Not for Redistribution 2 Overview countries are
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