East African Monetary Union remains a very bad idea (I have a better idea)

This is from the Kenyan daily The Nation:

East African Community leaders on Saturday signed the Monetary Union Protocol which is intended to result in a single currency in 10 years’ time.

The signing ceremony held at Speke Resort Munyonyo in Uganda was witnessed by Members of the East Africa Legislative Assembly, diplomats and high ranking government officials of member states.

President Uhuru Kenyatta was earlier installed as chairman of the EAC, a major regional role that will see him become the focal point in discussing East Africa’s response to serious challenges ranging from hunger to terrorism.

President Kenyatta joined host President Yoweri Museveni, Rwandan President Paul Kagame, Tanzanian President Jakaya Kikwete and Burundi President Pierre Nkurunziza first at a resort on the shores of Lake Victoria for formal EAC talks.

…The protocol will provide for a wide scope of co-operation in monetary and financial sectors among EAC members.

Under the protocol, EAC states are expected to surrender monetary and exchange rates policies to one authority leading to a single currency regime within the region.

The protocol will be implemented over a ten year period, subsequently leading to creation of a regional central bank whose mandate is to stabilise financial prices as well as monitoring, surveillance and enforcing compliance of all other macro finance matters.

President Kenyatta told the launch the monetary union will accelerate trade growth within the region.

I strongly believe that there are great economic benefits from further economic integration in East Africa and I generally am quite (very!) optimistic about the prospects for the East African economies. However, I continue to be extremely skeptical about the benefits of an East African currency union. I have written about this issue before – so let me quote myself:

The euro crisis should give African policy makers a lot of reasons why not to rush into currency union – even taking into account the present problems with credibility in the present monetary regimes in many African countries. The experience from the euro zone is that if sufficient economic, financial and political (and dare I say cultural) convergence is not achieved between the members of the currency union then it could have disastrous consequences.

The EAC (the East African Community) is a much looser union than the EU and just the fact that an internal market in Eastern Africa has not even been fully implemented should make one very cautious about EA monetary union. Despite of that work with monetary integration in the region goes ahead – even though the pace is much slower than had been the official political ambition.

…monetary union should not be rushed through. Rather policy makers should look for other possible reforms that will enhance trade and financial integration in Eastern Africa.

And the issue of lack of trade integration is an issue brought up in article in The Nation:

President Kenyatta urged member states to eliminate all the remaining barriers to free movement of people, goods and services.

“Barriers to trade in particular assail the spirit of the Common Market, Customs Union and the Monetary Union,” said President Kenyatta, calling for the removal of all obstructions to the growth of the community, stressing the need to allow free movement of people, businesses and capital within the community to provide opportunities for generating prosperity.

He also called on investors and other businesspersons to enhance their participation and commitment to empowering economic growth in the community.

“Businesses and traders in the small and micro-enterprises sector need to be enabled to trade in the regional arena. I commend the work done in this regard, especially through regional exhibition,” President Kenyatta said.

The President also said the envisioned integration will work as intended when underpinned by a sound infrastructure system, stressing that development of infrastructure connecting member states was key to the integration process.

To me it is incredible that policy makers would push ahead with any kind of monetary union given the very obvious lack of political will to make a real push for a true East African free trade area.

Let me instead repeat an old idea of mine – privatized and endogenous monetary integration in East Africa:

It is certainly not obvious that the present “monetary borders” in Eastern Africa are optimal. Just the fact that borders across Africa are highly artificial and to a large extent due to colonial history could e an argument for currency unions across different countries in Africa – including in Eastern Africa. However, there is no reason why such monetary integration should happen through the introduction of common (monopoly) currency in the EAC. In fact there might be a better privatised option in the form of the so-called M-pesa and other electronic payment forms.

Over the last couple of years M-pesa which is a mobile telephone payment system (M-pesa means Mobile Money) has become hugely popular in Kenya and in many ways M-pesa has led to a quasi-privatisation of the monetary system in Kenya and M-pesa clearly has the potential to become a fully privatised parallel currency in Kenya.

M-pesa has also been introduced in other Eastern African countries but the success has been much more limited in countries like Tanzania than in Kenya. I believe that the primary reason for the success of M-pesa in Kenya is the fact that authorities wisely have not applied banking regulation to the M-pesa. On the other hand M-pesa is much more regulated in other Eastern African countries, which most likely has hampered the expansion of the M-pesa (and similar payment systems) in other East African countries.

I believe that many of the advantages of monetary union could easily be achieved by enhancing the use of M-pesa style payment systems across Eastern Africa. The main advantage of currency union is the reduction of transaction costs, but this is also the main advantage of M-pesa style systems. So if the EAC wants to help monetary integration in Eastern Africa then it would make much more sense to agree on common regulation of M-pesa style payment systems and allow these systems to be used across the EAC. In that regard it should of course be stressed that this regulation should be as “light” as possible and should not hamper the development of electronic and mobile based payment systems.

The clear advantage of such solutions for monetary integration in EAC would be that it would become “endogenous” meaning that households and corporations would only use a “common” currency (in the form of for example M-pesa) if they benefit from the use of that “currency”. Hence, one could easily imagine that most companies in for example Tanzania and Kenya would start using M-pesa style payment systems also for cross border payments, while for example households in Rwanda would prefer another payment system. Monetary Union limits monetary competition. This should never be the purpose of monetary reform. On the other hand deregulation (and common EAC regulation) of mobile payment systems will enhance monetary competition and likely lead to a more efficient form of monetary integration. Said, in another way why not let the market decided on the size of the optimal currency area?

If the EAC nonetheless wants to go ahead with creating a common currency it should opt for a “parallel currency” solution where the national currencies are maintained and the common currency is created as a common “accounting unit”. This accounting unit could take the form of what George Selgin has termed Quasi-commodity money (QCM), where the money base is expanded at a fixed yearly rate for example 5 or 10% based on an automatic electronic algorithm. It would be natural that private suppliers of M-pesa style payment systems would use this common accounting unit as the reference unit of accounting.

This is basically a suggestion for a privatised monetary integration in Eastern Africa. If successful this would lead to monetary integration in Eastern African and significantly reduce transaction costs of cross-border transactions, which exactly is the purpose of the EAC’s proposal for monetary union, but it would avoid the problems associated with lack of economic and political integration.

Concluding, forget about East African monetary, focus on removing barriers to the free movement of goods, capital and labour in East Africa and leave monetary integration to the free markets.

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Forget about East African Monetary Union – let the M-pesa do the job

It is not only in Europe that the idea of currency union has considerable political backing. This is certainly also the case in Africa. In fact there is already de facto a currency union (officially two currency unions) in Central and Western Africa in the form of the two CFA franc zones. Furthermore, there are also discussions about currency unions in Eastern Africa and in Southern Africa.

The euro crisis should give African policy makers a lot of reasons why not to rush into currency union – even taking into account the present problems with credibility in the present monetary regimes in many African countries. The experience from the euro zone is that if sufficient economic, financial and political (and dare I say cultural) convergence is not achieved between the members of the currency union then it could have disastrous consequences.

I have come across an interesting new(ish) working paper (“Are Proposed African Monetary Unions Optimal Currency Areas? Real and Monetary Policy Convergence Analysis”) by Simplice A. Asongu that discusses convergence in Western Africa and in Eastern Africa. Here is the abstract:

“A spectre is hunting embryonic African monetary zones: the EMU crisis. The introduction of common currencies in West and East Africa is facing stiff challenges in the timing of monetary convergence, the imperative of bankers to apply common modeling and forecasting methods of monetary policy transmission, as well as the requirements of common structural and institutional characteristics among candidate states. Inspired by the premise of the EMU crisis, this paper assesses real and monetary policy convergence within the proposed WAM and EAM zones. In the analysis, monetary policy targets inflation and financial dynamics of depth, efficiency, activity and size while real sector policy targets economic performance in terms of GDP growth at macro and micro levels. Findings suggest overwhelming lack of convergence; an indication that candidate countries still have to work towards harmonizing cross-country differences in fundamental, structural and institutional characteristics that hamper the convergence process.”

Monetary union in Eastern Africa has for years been the official stated goal of the Eastern Africa Community (EAC). The countries in the EAC are Kenya, Tanzania, Uganda, Rwanda and Burundi.

The EAC is a much looser union than the EU and just the fact that an internal market in Eastern Africa has not even been fully implemented should make one very cautious about EA monetary union. Despite of that work with monetary integration in the region goes ahead – even though the pace is much slower than had been the official political ambition. For the latest official comments from EAC on Eastern African Monetary Union see here.

In my view Asongu’s paper clearly shows that monetary union should not be rushed through. Rather policy makers should look for other possible reforms that will enhance trade and financial integration in Eastern Africa.

Endogenous monetary integration with M-pesa

It is certainly not obvious that the present “monetary borders” in Eastern Africa are optimal. Just the fact that borders across Africa are highly artificial and to a large extent due to colonial history could e an argument for currency unions across different countries in Africa – including in Eastern Africa. However, there is no reason why such monetary integration should happen through the introduction of common (monopoly) currency in the EAC. In fact there might be a better privatised option in the form of the so-called M-pesa and other electronic payment forms.

Over the last couple of years M-pesa which is a mobile telephone payment system (M-pesa means Mobile Money) has become hugely popular in Kenya and in many ways M-pesa has led to a quasi-privatisation of the monetary system in Kenya and M-pesa clearly has the potential to become a fully privatised parallel currency in Kenya.

M-pesa has also been introduced in other Eastern African countries but the success has been much more limited in countries like Tanzania than in Kenya. I believe that the primary reason for the success of M-pesa in Kenya is the fact that authorities wisely have not applied banking regulation to the M-pesa. On the other hand M-pesa is much more regulated in other Eastern African countries, which most likely has hampered the expansion of the M-pesa (and similar payment systems) in other East African countries.

I believe that many of the advantages of monetary union could easily be achieved by enhancing the use of M-pesa style payment systems across Eastern Africa. The main advantage of currency union is the reduction of transaction costs, but this is also the main advantage of M-pesa style systems. So if the EAC wants to help monetary integration in Eastern Africa then it would make much more sense to agree on common regulation of M-pesa style payment systems and allow these systems to be used across the EAC. In that regard it should of course be stressed that this regulation should be as “light” as possible and should not hamper the development of electronic and mobile based payment systems.

The clear advantage of such solutions for monetary integration in EAC would be that it would become “endogenous” meaning that households and corporations would only use a “common” currency (in the form of for example M-pesa) if they benefit from the use of that “currency”. Hence, one could easily imagine that most companies in for example Tanzania and Kenya would start using M-pesa style payment systems also for cross border payments, while for example households in Rwanda would prefer another payment system. Monetary Union limits monetary competition. This should never be the purpose of monetary reform. On the other hand deregulation (and common EAC regulation) of mobile payment systems will enhance monetary competition and likely lead to a more efficient form of monetary integration. Said, in another way why not let the market decided on the size of the optimal currency area?

If the EAC nonetheless wants to go ahead with creating a common currency it should opt for a “parallel currency” solution where the national currencies are maintained and the common currency is created as a common “accounting unit”. This accounting unit could take the form of what George Selgin has termed Quasi-commodity money (QCM), where the money base is expanded at a fixed yearly rate for example 5 or 10% based on an automatic electronic algorithm. It would be natural that private suppliers of M-pesa style payment systems would use this common accounting unit as the reference unit of accounting.

This is basically a suggestion for a privatised monetary integration in Eastern Africa. If successful this would lead to monetary integration in Eastern African and significantly reduce transaction costs of cross-border transactions, which exactly is the purpose of the EAC’s proposal for monetary union, but it would avoid the problems associated with lack of economic and political integration.

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PS I use the term M-pesa here as a form of payment system rather than as the specific brand. Therefore, this post is not an endorsement of M-pesa, but rather an endorsement of monetary reform that allows the development of mobile and electronic payment systems in Africa.

PPS Simplice Asongu also has another related working paper that I can recommend: How has mobile banking stimulated financial development in Africa?

This post is part of my “Project African Monetary Reform” (PAMR). I am currently also working on a post on the experience with currency union within the CFA franc zone(s).

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Related posts:
The spike in Kenyan inflation and why it might offer a (partial) solution to the euro crisis

“Good E-money” can solve Zimbabwe’s ‘coin problem’

M-pesa – Free Banking in Africa?

Project African Monetary Reform (PAMR)

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This post has also been published as a guest blog at Centre for African Development and Security.

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