5 July 2008

East Africa: Resurrecting the East African Shilling


Kampala — The first incarnation of the East African Shilling, the common currency of the region, died an inauspicious death in 1969 after the collapse of British rule. Now, 40 years on, the authorities of Burundi, Kenya, Rwanda, Tanzania and Uganda are pressing ahead with plans to resurrect the currency.

Inspired by 12 European nations' switch to the Euro in 1999, the East African Community (EAC) this week placed advertisements in the international media searching for consultants to help it replace national currencies with a currency union by 2012.

But despite the EAC's urgency, economists are still unsure about the benefits of the East African Shilling, and whether it can actually be in use by its target date.

The East African Shilling would mainly benefit its members, economists say, by boosting intra-regional trade. It would eliminate the transaction cost and currency risk of selling goods across borders, as well as making regional price comparisons easier.

It would also make East Africa more attractive to international investors and traders, as a single regional currency would be more liquid and probably less volatile than five separate national currencies. It may reduce the sharp movements of East African currencies against the US dollar in recent months which have made investing in the region riskier.

Monetary union may also have political benefits, speeding up regional integration by helping create an East African identity - one of the EAC's main objectives.

Dr. John Mubazi, an economist at Makerere University, believes that monetary union could benefit the region. "It certainly is a good idea, as long as the fundamentals are in place," he says.

But, as Dr. Mubazi spells out, monetary union also has costs - mainly giving up monetary policy authority. Having a common currency means each country foregoes its ability to set its own interest rates and exchange rate policy. Instead, a common monetary policy is decided by a regional central bank.

This can be costly if, for example, economic circumstances in Kenya demand high interest rates but Tanzania needs a low rate. The regional central bank may set an intermediate rate that leaves neither country happy.

A common currency could also force national governments to give up some control over budgetary policies, limiting their ability to form their own taxation and spending plans. Euro members, for example, cannot run a budget deficit of more than 3% - if they do they can be fined. This is because if one member of a monetary union runs up a large government debt, the others suffer too.

So would the benefits of an East African currency be worth the cost?

Advocates of a common currency point to the success of the Euro, which provides the blueprint for the East African Shilling project. The common European currency has increased regional trade and reduced exchange rate movements, while helping to reduce inflation in some member states.

But it hasn't all been plain sailing for the currency with the United Kingdom, Denmark and Sweden all opting out of joining the Eurozone. They have judged that retaining their monetary policy independence serves them better than signing up for a common European one.

Moreover, the economic conditions in East Africa are not necessarily the same as they were in Europe.

The success of the East African Shilling will depend crucially on "how well integrated the [East African] economies are," according to Dr. Mubazi.

To encourage integration, the EAC has set out ambitious "convergence criteria" that the five members must meet before joining the currency union. These targets include inflation rates of less than 6%, real GDP growth of more than 7% and savings rates of above 20%, beginning in 2007.

Without "a sustainable convergence of economic fundamentals," Governor of the Bank of Uganda, Emmanuel Tumusiime-Mutebile, warned in a recent speech, "it may even be counterproductive to try and forge a monetary union."

There is little evidence that this convergence of fundamentals is taking place. Kenya's inflation rate is 29.3%, Uganda's is 12.4% and Tanzania's is 9.1% - all far above their 6% target level. On other criteria, like growth rates and budget deficits, countries are also falling short.

And a lack of convergence is not the only obstacle to a monetary union. "A common currency needs labour and capital to be mobile between members," Dr. Mubazi says. "I don't see that in East Africa at the moment."

A common monetary policy will also require an East African central bank, and creating such an institution - along with a large staff, premises and budget - by 2012 will be a challenge in itself.

The central bankers are adamant that the 2012 target date will be met. "Failure," according to Mr. Tumusiime-Mutebile, "is not on the agenda."

But many businessmen and academics are privately sceptical. "The way things are now, the timeframe might be too ambitious," says Dr. Mubazi. Just how ambitious becomes clear when the schedule for East African currency union is compared to the timetable for the Euro. The EAC was re-founded in 2001, a customs union was introduced in 2005 and a common currency is planned for 2012. By the time the Euro was created in 1999, a customs union had been in place for 31 years. The European Community itself was almost half a century old.

If the European experience is anything to go by, the East African Shilling may have to wait longer than planned until it breathes life again. A currency union by 2012 would be more than a resurrection - it would be a miracle.

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