A single EA currency is not feasible today
Aug 17, 2010
On July 1, 127 million people of East Africa (EA), a block of five nation states with combined purchasing power of $150b became a single market. In principle a trained chef in Kampala can get a job in a restaurant in Bujumbura, Quality supermarket can start a branch in Arusha or JESA dairy farm can
On July 1, 127 million people of East Africa (EA), a block of five nation states with combined purchasing power of $150b became a single market. In principle a trained chef in Kampala can get a job in a restaurant in Bujumbura, Quality supermarket can start a branch in Arusha or JESA dairy farm can sell its yoghurt in Uchumi in Nairobi.
There will be no border taxes on goods and services or restrictions on movements of labour, capital within the member countries. It is sunrise for the EA consumers, entrepreneurs and service providers.
Deepening further the process of integration, plans are in high gear for EA to have a common currency by 2012.
The key question is; can a single currency succeed before a political union in EA? In this piece I explore some of the potential challenges of sovereign states under a common currency.
First, there has not been a smooth implementation of a currency union without a successful political union in human history. The challenge of having fives states with one central bank, single monetary policy without a common treasury can be daunting.
The modern model of a common currency, the Euro-zone is now in disarray because of this structural flaw in design i.e, a common central bank, the common currency (the Euro) but each of the 16 Euro-zone member countries has its own treasury and the Euro-zone is under threat of disintegration.
The European Union countries had similar ambitions like the EAC, but the political union agenda has dragged on and it increasingly gets unlikely that there will ever be a united states of Europe. Will the EAC follow suit if it adopts similar flawed structural design of the integration process? Ironically, the EAC`s monetary affairs committee has out sourced the services of the European Central Bank to guide the process of attaining a single currency.
Normally, a government of a sovereign state has two policy instruments for steering its economy to create jobs for its citizens. They keep prices of goods and services stable (control inflation), keep its exports competitive, sustain long run individual and national income growth (GDP) per capita growth and GDP) and maintain macroeconomic stability.
Typically, a central bank manages monetary policy via controlling quantity of money in the economy, interest rates, maintaining prices of goods, services and exchange rate stable. Thus, monetary policy decisions are largely technical and not political, and central banks are supposed to be independent.
When nations join in a monetary union before a political union, it means that a typical member state will have no decision power over the key elements of monetary policy alone. A nation would not be able to control money supply and interest rates to stabilise prices of goods and services and control exchange rate for export competitiveness.
Usually, political and development needs will determine the national budget revenue sources and expenditure priorities.
This is where the problem begins. The European experience reveals that when countries manage their national budgets with different politically guided fiscal policy priorities under a single regional monetary policy, there is bound to be a mismatch. So a common treasury is an essential component for successful integration.
Second, with labour productivity differing significantly in the EAC region with Kenya at the top, more unemployed people, language barriers, movement of workers in the region will be less than perfect.
This, with standardised fiscal and monetary policy discipline, will hurt the weaker members of EAC. For instance, focusing on fiscal policy through budget targets could curtail individual government development projects, stifle employment creation, and reduce tax receipts and exports competitiveness.
This could lead to overall downward spiral in demand of goods and services. Therefore, a single market and currency union are only small steps that can lead forward or stall the integration process. The EAC needs to move a political federation rapidly.
There will be no border taxes on goods and services or restrictions on movements of labour, capital within the member countries. It is sunrise for the EA consumers, entrepreneurs and service providers.
Deepening further the process of integration, plans are in high gear for EA to have a common currency by 2012.
The key question is; can a single currency succeed before a political union in EA? In this piece I explore some of the potential challenges of sovereign states under a common currency.
First, there has not been a smooth implementation of a currency union without a successful political union in human history. The challenge of having fives states with one central bank, single monetary policy without a common treasury can be daunting.
The modern model of a common currency, the Euro-zone is now in disarray because of this structural flaw in design i.e, a common central bank, the common currency (the Euro) but each of the 16 Euro-zone member countries has its own treasury and the Euro-zone is under threat of disintegration.
The European Union countries had similar ambitions like the EAC, but the political union agenda has dragged on and it increasingly gets unlikely that there will ever be a united states of Europe. Will the EAC follow suit if it adopts similar flawed structural design of the integration process? Ironically, the EAC`s monetary affairs committee has out sourced the services of the European Central Bank to guide the process of attaining a single currency.
Normally, a government of a sovereign state has two policy instruments for steering its economy to create jobs for its citizens. They keep prices of goods and services stable (control inflation), keep its exports competitive, sustain long run individual and national income growth (GDP) per capita growth and GDP) and maintain macroeconomic stability.
Typically, a central bank manages monetary policy via controlling quantity of money in the economy, interest rates, maintaining prices of goods, services and exchange rate stable. Thus, monetary policy decisions are largely technical and not political, and central banks are supposed to be independent.
When nations join in a monetary union before a political union, it means that a typical member state will have no decision power over the key elements of monetary policy alone. A nation would not be able to control money supply and interest rates to stabilise prices of goods and services and control exchange rate for export competitiveness.
Usually, political and development needs will determine the national budget revenue sources and expenditure priorities.
This is where the problem begins. The European experience reveals that when countries manage their national budgets with different politically guided fiscal policy priorities under a single regional monetary policy, there is bound to be a mismatch. So a common treasury is an essential component for successful integration.
Second, with labour productivity differing significantly in the EAC region with Kenya at the top, more unemployed people, language barriers, movement of workers in the region will be less than perfect.
This, with standardised fiscal and monetary policy discipline, will hurt the weaker members of EAC. For instance, focusing on fiscal policy through budget targets could curtail individual government development projects, stifle employment creation, and reduce tax receipts and exports competitiveness.
This could lead to overall downward spiral in demand of goods and services. Therefore, a single market and currency union are only small steps that can lead forward or stall the integration process. The EAC needs to move a political federation rapidly.