East Africa: The Agony of Central Banks

Source from:  The East African (Nairobi) 2 November 2008 11/05/2008

How I hope that East Africa will one day have a supranational central bank with the appropriate policy instruments and the independence to conduct a single monetary policy. Given the snail's pace at which the integration of the economies of the East African Community is going, a monetary union remains a very long shot. Yet our three central banks are right now facing very similar challenges and pressures. The currencies of the three countries are in free fall against the US dollar, having taken a major beating from the scary goings-on in the international financial markets. Consider the following: Since October 1 this year, the Kenya shilling has depreciated against the dollar by nine per cent. The Uganda shilling has fallen by 18 per cent while the Tanzania shilling has depreciated by 12 per cent. And, it is not as if something terrible had suddenly gone wrong in the macro-economies of these three partner states of the East African Community. More than anything else, what we are seeing here is the impact of both the spate of scaremongering and the apocalyptic predictions we are being fed by the international media. Neither the Bank of Tanzania, the Bank of Uganda nor the Central Bank of Kenya suddenly ran out of dollars to precipitate such volatility. As a matter of fact, the Bank of Tanzania this week announced that it was holding reserves of $2.7 billion in its vaults. This has in fact been the level of foreign reserves for the country for the past 18 months. So why is the Tanzania shilling exhibiting such extreme volatility? When you look at the foreign-exchange reserve positions of these countries right now, you will not see any correlation with what is happening in the currency markets. PRICES ARE SUPPOSED TO move up and down depending on supply and demand. But what we are witnessing now is mainly a product of speculation. Currency dealers and traders are advising their clients to buy as many dollars as they can now right now. International institutions with shilling accounts are being advised to liquidate and buy dollars. Speculators have calculated that dollars will be very scarce in the near future. If you have plans to import a car from Europe next year, the dealers will advise you to buy the dollars now and keep them in a forex account with your commercial bank. The upshot is that artificial shortages have been created in the marketplace by the activities of hoarders. Hence the heat that the three currencies of the region are feeling. The choice that the central banks of the region now face is whether to intervene to stabilise their currencies. If, as a central bank, you sell what you have in your reserves right now, you will increase the supply of dollars in the marketplace, and hence reverse the downslide. A quiet debate is now raging over whether the central banks should intervene in the market. Yet the truth of the matter is that none of the central banks of the region can afford to sell scarce dollars right now. We are living in very uncertain times. Intervening in the markets amounts to spending scarce national resources on subsidising the operations of private companies. At the end of the day, it is the big consumers of dollars such as multinational oil companies who will benefit from interventions by Bank of Tanzania, Bank of Uganda or the Central Bank of Kenya. In the coming months, East African government are likely to be forced by circumstances to import food and fertiliser. Clearly, the opportunity cost of selling foreign exchange reserves to stabilise the currencies is very high indeed. The priority right now should be to spend the dollars on buying medicines, food and fertiliser, not selling them to speculators. The unfortunate thing is that the central banks in the region don't have much leverage over speculators. Which is why they have resorted to public statements warning markets against speculation. Their's has been a voice crying in the wilderness. The Bank of Tanzania has taken a different approach altogether. Last week, it put out a statement announcing that it will only sell dollars to a few key importers whose operations have big economic benefits to the country. The statement by BoT added that dollars would only be sold to oil, energy and telecommunications sectors. Meanwhile, interesting trends are emerging. Why are our currencies weakening against the dollar in such an asymmetric manner? Although all three currencies, of Uganda, Kenya and Tanzania, have been falling against the dollar, the Ugandan currency has been hit the hardest. What does this tell you? If you discount the speculation factor, what we are seeing is a reminder that East Africa is still very far from achieving the preconditions for a monetary union. THE TREND IS A POINTER TO the fact that we have divergent trends with regard to terms of trade. There are significant cross-country differences in export composition with the two top export products for the three countries being different -- tea and horticulture for Kenya; gold and tobacco for Tanzania; and coffee and fish products for Uganda. Since the three countries have divergent terms of trade, it is no surprise that their currencies are reacting differently to external shocks. There are also significant differences in external openness among the three countries. In theory, the phrase "optimum currency area" is used to describe the preconditions that a region must put in place before it can achieve a monetary union. FOR THE REGION TO START moving towards the status of an optimum currency area, Tanzania, Uganda, and Rwanda must start reducing their dependence on aid to fund the budget. We will also need to harmonise the reforms of our banking systems. Convertibility and capital mobility will also be crucial in the transition to a common currency for the region. For foreign-exchange transactions between EAC countries, agreements already exist. What we don't have is convertibility vis a vis third-party countries. Kenya, Uganda an Tanzania maintain an exchange rate system that is free of restrictions on the makings of payments and tranfers for current international transactions. But in Tanzania, various controls still exist for certain capital transactions. Uganda has made good progress in eliminating controls, with restrictions remaining only on the areas of real-estate transactions, maintaining accounts abroad and lending to non-residents. Labour mobility will also be a factor. Although initial steps have been taken to encourage labour mobility within the EAC, a free flow of labour is yet to be achieved. Member states are still hesitant to allow foreign workers to enter the domestic labour market. In the ongoing negotiations on the protocol for a Common Market for the EAC, immigration and movement controls have proved to be deeply controversial. When you talk about a monetary union for East Africa today, cynics will dismiss you. Yet the truth of the matter is that if we don't integrate the economies, we will continue to be marginalised in world trade. Africa cannot make an impact in world trade because of distorted trade regimes and high transaction costs. Among all other regions of the world, African countries have the most restrictive regimes, characterised by high tariffs, arbitrary tax exemptions and a host of non-tariff barrier.The bigger the economic grouping, the better. This idea of creating a Free Trade Area for Comesa , SADC and the EAC was a brilliant one. Enditem