Economic Diversification and Growth

Chapter 7
IV. The Positive and Negative Impact of a
Future Monetary Union
Table 7.5: Correlation Coeffici
ts of Business Cycles among EAC Countries
7.29. The EAC countries have decided to move ahead
with monetary integration through the creation of a
monetary union. In November 2013, all the EAC members,
including Uganda, signed a protocol creating the monetary
union. They agreed to implement the preliminary stages of
monetary integration within two years and to establish the
fiscal foundations of a common currency within ten years
(in 2024). Box 7.1 outlines the process and describes the
convergence criteria for the EAC monetary union.
7.30. A monetary union can generate benefits. The main
benefits include the creation of a credible central bank,
reducing trade costs and minimizing the risk of importing
recessions. The creation of an independent monetary
policy-making body makes it more difficult for any individual
member government to influence monetary policy decisions.
A single currency in a monetary union would also
stabilize nominal prices and lower transaction costs within
the union. Monetary unions harmonize regulations and
tax collection systems, and provide freer access to capital,
and this also reduces cross-border transaction costs. Finally,
monetary policy within a union responds to domestic
economic conditions, and so would be less likely to import
recessions than a peg.
7.31. A monetary union also comes with costs, including
limited capacity of independent monetary policies, higher
risk of sovereign default, and the virtual impossibility
of reversing the move towards monetary integration.
Although a monetary union improves the credibility of the
monetary authority, the benefit is less significant in developing
countries with low levels of financial intermediation.
1990-2010 2001-2010
BI KE RW TZ UG BI KE RW TZ UG
Burundi (BI) 1 1
Kenya (KE) -0.1 1 0.5 1
Rwanda (RW) 0.3 0.1 1 0.7 0.3 1
Tanzania (TZ) 0.4 0.6 0.4 1 0.8 0.7 0.5 1
Uganda (UG) 0.03 0.7 0.1 0.7 1 0.9 0.6 0.6 0.9 1
Source: Rusuhuzwa and Masson (2012).
Table 7.6: Correlation Coeffici ts of Terms of Trade Shocks with Medium Future Energy Exports
BI KE RW TZ UG
Burundi 1.00
Kenya -0.46 1.00
Rwanda 0.89 -0.28 1.00
Tanzania -0.58 0.93 -0.53 1.00
Uganda -0.46 0.97 -0.35 0.97 1.00
Source: Masson (2012).
Within a currency union, countries no longer issue debt in
a currency they control. Therefore debt cannot actively be
reduced by inflation, and counter-cyclical fiscal policy may
be constrained by concerns about the ability to service debt.
It is also very difficult to reverse the process, once a monetary
union system has been introduced. A good example is
the recent crisis of the Eurozone, where members of a monetary
union can only adjust relative prices through inflation
or deflation and lack other monetary instruments to defeat
the crisis.
7.32. Monetary unions are often considered to be best
suited for countries with similar growth paths. The EAC
countries, particularly the original three members (Kenya,
Tanzania, and Uganda), have similar growth paths and are
vulnerable to similar shocks. Table 7.5 shows that, traditionally,
the business cycles of Kenya, Tanzania, and Uganda
are closely correlated. Over the past ten years, however,
correlations improved between business cycles in Burundi
and Rwanda on the one hand and Kenya, Tanzania and
Uganda on the other hand.
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Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility