East African Monetary Union: An impossible project?

The East African Community (EAC) has failed to meet its 2012 target of agreeing on the formation of a monetary union.

After almost two years of negotiations, the five East African Community countries appeared to be reaching agreement on how an East African Monetary Union will be formed and it was expected that a protocol would be approved at the EAC Heads of State Summit at the end of November. This would have started the process of monetary integration, the third of four major steps on the way to a federation of the five countries into a single state.

However, the EAC countries were unable to come to an agreement, and the monetary union was removed from the summit agenda. Instead, a new target for the completion of negotiations has been set for 2013.

This is not the first time that the east African countries have tried to integrate. The EAC was originally formed in 1967 and both a customs union and a common market were established. Despite being seen as a successful example of regional integration, much more advanced than the European Community was at the time, the EAC collapsed after just ten years. This was due to political and economic differences between the three member states.

The revival of the EAC in 2000 set out the intention of the EAC members, then Kenya, Tanzania and Uganda, to form a political federation. As transitional steps, the community would again establish a customs union, a common market and then a monetary union.  The community has since expanded, with the admission of Burundi and Rwanda in 2009 and both a customs union and a common market have been launched.

It is envisaged that a stable monetary union will reduce the costs of doing business across borders within the EAC, thereby deepening trade links and promoting growth. There is also an expectation that a common currency will encourage investment in the region.

The EAC is keen to expedite the process of forming a monetary union; however, this optimism about the prospects of a quick integration may be misplaced. The customs union and common market have still not been implemented in full and there are doubts about the viability of a monetary and political union. Although another collapse of the EAC is highly unlikely, there are significant obstacles blocking the smooth process of integration.

The crisis in the Euro zone has demonstrated the importance of ensuring that the economic preferences of monetary union member countries are aligned. This requires an economic convergence process, which will allow a common monetary policy to be appropriate for all countries in the union.

“The EAC Secretariat has a budget of only $55m per annum. It is significantly under-resourced to deliver the ambitious agenda of regional integration.”

As it stands, there are significant differences between the five EAC economies. GDP per person in 2011 ranged from $271 in Burundi up to $808 in Kenya, whilst inflation in Uganda that year was more than three times that of Rwanda (19% versus 6%).

Reliance on aid also differs significantly with Burundi receiving aid equivalent to 31% of its GDP and Rwanda 18% of its GDP. Kenya, meanwhile, receives the equivalent of only 5% of its GDP. Furthermore, the recent cutting of aid to Rwanda and Uganda is likely to hit those economies hard, slowing any attempts at meeting convergence criteria.

Such large differences will take time to iron out, however, the EAC has appeared unwilling to wait. The community has previously stated that it hopes to complete the convergence process by 2016. After the failure to complete negotiations by the November summit, this has been revised with the EAC now expecting the convergence process to take up to 10 years. Although not directly comparable, it is worth noting that the convergence process for the Euro took almost 30 years and even still macroeconomic divergences remained.

The recent discoveries of oil and gas reserves in the region also pose an obstacle to a swift monetary integration. Although the exact extent of the discoveries is still unclear, it is estimated that the region’s reserves are significant. If these estimates are accurate the revenues from these resources will change the structure of the economies of Kenya, Tanzania and Uganda, with them becoming net exporters of energy. Burundi and Rwanda, however, will remain as net importers of energy.

The discovery of these resources creates two problems for a monetary union. Firstly, whilst the economies of Kenya, Tanzania and Uganda will become more similar, they will differ much more from Burundi and Rwanda than at present. For example, rising oil and gas prices would be beneficial for the three producing countries, but would have a negative impact on the other two. In such a situation the oil and gas producers would want a tight monetary policy to control their economies, whereas Burundi and Rwanda would want the opposite.

As Burundi and Rwanda are by far the two smallest economies in the EAC, they will have the least influence over monetary policy in a union. Despite the benefits of regional integration for these two landlocked countries, the cost of entering into a monetary union could be too costly if these issues are not dealt with properly beforehand.

The second oil-related problem that faces the monetary union project is the so-called ‘Dutch Disease’. This is where an influx of foreign investment appreciates the exchange rate, making other industries less competitive. As a result, the economy becomes ever more reliant on its oil and gas. Here again Burundi and Rwanda would suffer from being in the monetary union as they have no oil or gas sector to fall back on.

In order to prevent such splits in the community, the EAC has suggested that oil and gas revenues be shared between all EAC countries. This is likely to be politically difficult. There are already tensions in some EAC countries over locally generated revenue not benefiting local communities. Tanzania has recently resolved a dispute with the semi-autonomous island of Zanzibar about the sharing of oil revenues, whilst there is increasing anger on the Kenyan coast as many feel that coastal activities do not benefit coastal people. Sending money to another country is, therefore, unlikely to be popular and politicians may be reluctant or unable to implement such a policy.

There is a need for both strong political will and widespread public support to overcome these obstacles to integration. “Politically tough decisions are needed” explains Frank Matsaert, CEO of TradeMark East Africa, an organisation that provides the EAC with technical support aimed at enhancing regional trade and integration. “There is strong political will amongst Heads of State in the EAC to ensure that integration is successful. However, this requires sustained commitment to reform at both political and technical levels at the EAC Secretariat and in each member state.”

Strengthening of EAC institutions will also be required. This will need to include increasing the powers of the EAC and particularly allowing sanctions to be imposed on countries that do not adhere to rules or implement policies. A lack of funding is also a problem, which weakens the community institutions. “The EAC Secretariat has a budget of only $55m per annum. It is significantly under-resourced to deliver the ambitious agenda of regional integration” explains Frank Matsaert.

But it is not just a series of political and technical reforms that is required. A successful monetary, and ultimately political, union will require a change in the mind-set of people in the region. The EAC is aware of this and is forming a policy to promote an East African identity to replace national identities. If people see themselves as an East African, rather than a Kenyan, Tanzanian or Ugandan, perhaps they will be more willing to make sacrifices for their fellow East Africans.

This won’t be easy. The 2008 post-election violence in Kenya exposed deep divisions within Kenyan society. Despite efforts to promote a Kenyan identity, little appears to have changed. On the back of these difficulties, the promotion of an East African identity may well prove even harder. Elsewhere, Zanzibar’s independence movement indicates a growing focus on local identities; whilst Burundi does not have strong cultural and historical ties to the rest of the region. Forming a regional identity that can apply to everyone in the EAC will be a complicated, but necessary, task if deeper integration is to be achieved.

The EAC clearly has a long way to go before a monetary union can be completed. Although the numerous obstacles to deeper integration and monetary union can be overcome, a great deal of patience is needed. It will take time to assess the effect of oil and gas on the region and to develop a politically acceptable strategy for dealing with this. Entering into a monetary union before the people and the economies are ready could do more harm than good.

The current delays in agreeing on a protocol may indicate an acceptance that integration is a gradual process and not one that can be rushed. It is more likely, however, that the delays are caused by the five EAC countries each sticking up for their national interest. Whatever the reason for the delay is, more time examining the issues can only be beneficial.

Photo: noodlepie