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Area: Africa

Why East Africa’s Proposed Currency Union Is Not A Good Idea

The East African Community (EAC) is currently a customs union between five East African nations: Kenya, Uganda, Tanzania, Rwanda, and Burundi. As part of their plans to increase regional economic activity, four of the five countries (ex-Burundi) signed an agreement to form a currency union in ten years and adopt a shared currency. This was the natural continuation of their original plans when their customs union was first formed, and at first glance it looks to be a promising sign of further economic development in the region.

Yet times now are much different than when the EAC first embarked on their plans for economic integration back in late 1999. The timing is especially curious given the high profile problems the world’s most famous currency union, the European Union and the Euro, has faced since the financial crisis of 2008. With so much being discussed just last year about the EU splitting apart, it is with great apprehension that we view the EAC’s current plan to adopt a common currency in a decade’s time.

Here are some of the issues we see with the arrangement:

  • Using a common monetary policy for five countries that are in distinctly different stages of development, with different levels of GDP growth and inflation, is a juggling act that will be extremely difficult to maintain. The EU has helped drive home this point as we see Germany thrive with an artificially cheap currency (for them) while less competitive countries like Spain or Greece struggle to adjust without being able to devalue their currency. Just among the five countries in the EAC, you have two relatively tiny, undeveloped countries in Burundi and Rwanda, and the original big three of Kenya, Tanzania, and Uganda. They are at different stages economically, with varying GDP growth rates (from 4%-4.5% in Burundi and Kenya, to almost 7% in Tanzania) and inflation rates (from 5% in Rwanda up to 12% in Burundi) for each.
  • All five countries unsurprisingly run large current account deficits, meaning the future performance of the collective currency does not bode well despite hopes for greater stability in a currency union. However, as the more developed economies like Kenya and Tanzania increase overall exports and diversify outside primary commodity based industries, the resulting appreciating pressure on the currency would be detrimental to the less developed economies like Burundi and Rwanda. These issues will arise sooner rather than later, with Kenya having discovered a large new oilfield to join both Uganda and Tanzania as oil producers/exporters.
  • The currency union as currently structured already recognizes the huge disparity between the four countries by excluding Burundi from initial plans. When 20% of the EAC is already not included, it should be a sign that economic cooperation should be pursued via other avenues rather than a common currency.

We understand that the whole region seems to be moving towards unified currencies with West Africa and Central Africa  already using the CFA Franc, and the West African contingent working to adopt a new currency, the eco. However, we leave our note not by harping on the negatives but presenting an optimistic portrait of a country that benefited greatly from not joining a currency union: Poland. Businessweek recently did a nice profile on Poland’s recent economic success, attributing much of it to the ability to adapt to new markets by devaluing it’s currency. You can find the article: here.

 

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