Options for achieving monetary union

Despite disagreements among some member states of the East African Community (EAC), plans for a monetary union, hopefully in the near future, are in full gear.

Such a union would mean the end to national currencies, in favour of an East African unit to be adopted by all partner states.

In fact, during their last summit, the EAC Heads of State issued a directive to the Secretariat to fast-track the establishment of a monetary union by 2012. That may look like a tall order, but so was a Customs Union. That is now a reality.

However, a word of caution: A similar experiment by the Economic Community of West African States (Ecowas) faced huge problems because of vast disparities in income, incessant squabbling and political instability, and has not matured. That, however, should not be a deterrent to EAC efforts, but rather a lesson to avoid the same pitfalls.

The EAC recently released a discussion paper that examines the hurdles and benefits of a monetary union among the partner states. Put together by project teams of the EAC and the European Central Bank, this interim document is an interesting and illuminating read.

What must be done before full monetary union? There will be a need for convergence of economic policies and performance in all the member states, as well as similar growth towards fiscal discipline and better cooperation in the monetary and exchange rate areas.

Much work will be needed to set up uniform legal and institutional frameworks necessary for the establishment of a single currency. Stakeholders include the central banks, ministries of trade, industry, finance, planning, EAC affairs, capital markets, bureaus of statistics and bankers’ associations. It is important they begin an open and vigorous discussion on this matter. Ours is not to prejudge the recommendations the project teams will make, but to stimulate debate on them.

Currency unions are created within the larger context of a customs union, to facilitate the free movement of persons, services, goods and capital within the single currency area. A monetary union will require a single monetary and exchange rate policy that will not necessarily address national imbalances. Thus, it is to be expected that in the first few years after its establishment, there will be losers and winners.

Synchronised cycles

Gone will be the freedom of governments to pursue national monetary and exchange rate policies as macroeconomic policies converge. For a smooth transition and near uniform benefits to all EAC partner states, the currency union will require that monetary and economic policies be similar to a larger degree.

Partner states will adopt synchronised economic cycles, experience the same shocks from fluctuations in commodity prices, for instance, and similar inflation and growth rates. Bilateral exchange rates will be more stable and there should be more trade, financial flows and cross-border movement.

Integration of financial and capital markets will be necessary for monetary policy to work. The byword here is ‘expanding the space available for trade and development’. Should there first be a firm political commitment n the form of a protocol laying out the measures necessary before plodding ahead with the agenda of a single EAC currency?

Another option would be get the states to rely on stakeholder institutions to be the catalysts for a drive towards a single monetary union, with reforms being sector-specific.

The latter worked well in the drive towards the EAC Customs Union and could be the best way forward, to avoid getting bogged down by political bickering.

However, it would mean that initially, only those countries that are moving in the same direction will first achieve monetary integration, with the others joining at their own pace.

Whichever option is adopted, it will be important that the Secretariat muster the necessary political will to move it along. They must come up with common objectives, similar monetary policy instruments and a uniform exchange rate regime.