The Eurozone Crisis and Lessons for the Formation of an East African Monetary Union

The eurozone crisis has broader impacts than just for countries of Europe. There are quite a few implications for Africa since closer economic integration in the continent has been touted as an important strategy to expand markets and the trade of goods between African countries. A common currency in Africa, such as the CFA franc, is supposed to enhance intra–African trade by eliminating exchange rate volatility, reducing transaction costs and facilitating capital flows within the region. The East Africa Community (EAC) is one of the regional economic blocs in the process of coming together. While a lot of progress has been made toward EAC integration, things have not been so straightforward. Policymakers working on EAC integration have been approaching the adoption of a single monetary union with caution given the ongoing sovereign debt crisis in Europe. There are certainly lessons from Europe that the East African countries can take to heart as they attempt to move toward a single monetary union.

The EAC was first attempted in 1967 and then collapsed in 1977 due to political differences between Kenya, Tanzania and Uganda. Negotiations for the current EAC began in 1993, the permanent tripartite was signed, and the East African Customs Union and common market protocol became operational in 2010. The fast approaching deadline for the launch of the East African Monetary Union is June 2012 and EAC leaders have taken notice of the current turmoil in Europe. The EAC permanent secretary, Stergomena Bamwenda, has mentioned that if the necessary conditions are not in place before 2012 then the EAC will not go forward with the single monetary union. However, the EAC has continued to accelerate integration toward a monetary union with the development of a task force to address policy gaps that have been highlighted by the eurozone crisis.

Two main policy gaps in formation of the euro area have left it in its current state of instability. First, the design of the eurozone did not provide a contingency plan or safety measures to deal with sovereign debt crises. There is no protocol for member states should they find it difficult to access markets to refinance their sovereign debt. Second, 17 sovereign fiscal authorities govern the euro, which means it takes a lot of coordination to get anything done. In addition, there are no compelling mechanisms to enforce the commitments of member states. Some clear lessons emerge from the eurozone crisis that directly relate to the EAC and its path toward creating a single monetary union.

First, the process of further monetary integration of the EAC should not be expedited. Given the circumstances in Europe, it may be wise to wait and see how the euro-area crisis is handled. This will allow African policymakers to take stock of any lessons from Europe, which can help them decide whether move toward or away from the EAC shilling. Even before the eurozone crisis, experts urged the EAC to move slowly regarding the monetary union and to be wary of inflation caused by volatile oil prices. With discovery of oil in Uganda, the threat of price volatility is certainly more eminent.

The second takeaway from the euro-area crisis is that fiscal and monetary policies are not enough to ensure sustainability against the lack of full-blown coordination of economic policies. Euro-area countries pursued different structural policies and as a result competitiveness differentials widened throughout the decade, leading to substantial imbalances within the euro area. For instance, Germany has been able to accumulate substantial current account surpluses while the peripheral economies in Europe were doing just the opposite and running current account deficits that resulted in higher debt. Had these imbalances been corrected earlier, the crisis would have been much less severe or may not have occurred at all. Even following the recent European Summit, there still seems to be no hint of coordination of macroeconomic policies. Instead, all European countries will retrench their budgets, which will set the pace for a deflationary adjustment by uniformly compressing aggregate demand throughout the euro-area.

Similarly, the EAC countries are pursuing differing structural policies even as they negotiate the deal for a currency union. While the EAC agreed upon the criteria for macroeconomic convergence, issues of fiscal sustainability have not been met by member countries. For example, the budget deficit level criterion is set not to exceed 5 percent of GDP. Yet, according to the August 2011 EAC Strategy Report, Kenya, Uganda, Tanzania and Rwanda all have deficits exceeding the recommended target. The upper inflation limit was also set at 5 percent, but the same five countries are grappling with high levels of inflation above 10 percent, coupled with high currency volatility. Reserve criterion and management have yet to even be decided upon. The rationale of choosing these criteria is that they are seen as attainable goals for members— high enough to encourage spending for development, but low enough to be sustainable in the long-term. Unless, the EAC wants to recreate the mistakes of Europe it should pay strict attention to the fiscal benchmarks and other macroeconomic convergence criterion requirements.

Finally, the euro-area crisis highlights the importance of an independent central bank for the region that will guide monetary policy formulation and implementation. In addition, the central bank must enforce prudential financial regulations for the financial sector of member countries. The East Africa Central Bank is planned to be formed along the lines of European Central Bank (ECB). Thus, one must consider the institutional deficiencies of the ECB in order to avoid falling into the same trap that the ECB is currently in. A crucial gap in the euro area is what to do when there is a run on government bonds since the ECB does not have a mandate to intervene. Nor is there a crisis management facility, such as an enhanced European Monetary Fund. The fiscal crisis has spilled over to the banking sector, for which there is no central supervision or a central or federal deposit insurance mechanism. In sum, the current treaty for the East African Community, unlike the one for the current EU euro area, needs to spell out safety measures and a bailout plan in case of debt or other fiscal problems among members.

The formation of the monetary union is a challenge given the great imbalance in individual national economic strengths of the EAC countries. They must be prepared to give up a degree of sovereignty and to converge politically to avoid collapse. The ideal integration situation is where the countries in the union share common monetary and fiscal policies, a common pool of foreign exchange reserves, and a common monetary authority or central bank. Otherwise, trying to operate a single currency without social, economic and political integration is likely to fail as evidenced by eurozone crisis.

For the time being, the EAC is better off slowing down the integration process. The 2012 monetary union launch is only feasible if all of the macroeconomic convergence criteria are met and harmonization of all fiscal, financial and monetary policies is complete. Instead of rushing to move into a currency union, regional integration in the East African Community should focus more on trade expansion and infrastructure coordination. Whatever the EAC countries decide, the process of forming a single monetary union should be carefully considered given the ongoing turmoil in Europe and the EU’s failure to resolve the problem.