Lessons from Greek crisis as EAC seeks common currency

Region needs to learn from monetary challenges that European Union is facing that it hadn’t anticipated before integration, writes Mbui Wagacha

EAC heads of member states at a past function: Does any member country have the financial muscle to mobilise a bailout—with or without the IMF? Photo/FILE 

BY Mbui Wagacha

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Acting mostly in their self-interest, leaders occasionally challenge their countries and regions to greater heights; and succeed.

When they stumble, going back can be messy.

Examples are the exploits of the British empire for its people, or the United States, which achieved greatness via its version of Mau Mau— breaking away from British control.

The European Union (EU) is a positive example.

Yet its struggles, trapped in a Greek fiscal tragedy, demonstrate that when leaders implement leaky ideas, even foreign taxpayers pick the bill. In economic integration, the East African Community (EAC) has learned quickly from the EU.

It seems to be the newly confident kid on the block, enjoying new members and the rumoured applications of others to join.

While EAC commands a market of 127 million people, a combined gross domestic product (GDP) of $73 billion and oil and gas discoveries among other benefits have emboldened the dreams of integration.

In the next few years, the region could be flush with petro-dollars.

The five EAC states—Kenya, Uganda, Tanzania, Rwanda and Burundi— contemplate a common currency.

It would be a centerpiece of EAC.

The benefits are numerous: cheaper transactions, safer cross-border investments, capture of a quantity known as seignorage, etc.

To avoid driving the EAC’s vehicle into a gully, the authorities had better study the unfolding story of the EU.

While Greece had difficulty explaining its fiscal irresponsibility—some say dubious accounting of public debt that rose to above 12 per cent of GDP, well above EU’s three per cent benchmark— accords to offer support have stopped a noisy brawl; but not before the euro took historic knocks, depreciating considerably.

Political pressure is rife. Some members conditioned support on procurements of military equipment.

Yet, it is the monetary lessons, not the fiscal that should worry the EAC most.

The architects of European integration would be appalled.

They envisioned a rosy future shed of national identities, rejuvenated with a European identity.

The picture blurred recently as old resentments re-emerged.

It has seemed that decades of German fiscal discipline to nurture integration are squandered on wastrels to the south of the EU-Spain, Italy, Portugal and Greece.

With the euro shaken, markets have punished Greece with record spreads between its bonds and equivalents issued to Germany (yields of six per cent, twice the German rates).

On March 26 2010, EU pondered bailouts in a support mechanism roping in the International Monetary Fund (IMF). If activated, it could bring down the spreads.

The support is reminiscent of recent US bank rescues, this time across European borders.

But domestic politics oppose fiscal bailouts. US-type replication is problematic even in theory.

To work, the support would need massive financial resources complemented with flexibility of labour and resource movements that allow price adjustments across EU borders.

Since workers and capital do not move as easily across Europe as they do, say, across States in the US (or between Kenya and Rwanda—to provide an example closer to home following recent accords on labour movements between the two countries) the crisis exacerbates cross-country differentials in inflation rates and production costs.

Other policy instruments that would help adjustment to Greece-style crisis are automatic stabilisers such as operated in US through social security and medicare.

However, the EU has little in these.

Despite being a trailblazer with many successes behind it, the EU sacrificed years of progress backed with cutting-edge economic theory at the altar of the euro.

Leading economists, especially across the Atlantic, warned early about euro creation as an irrational challenge driven more by discontent on the supremacy of the US dollar in world trade than by hard-nosed timing and economic concepts.

While in ascendency, the euro captured many of the benefits targeted by the EAC common currency plan.

It took its place among reserve currencies that the world keeps in its coffers.

Trade, reduced investments risks and cheaper transactions all lifted EU’s poorer southern economies, handsomely.

A newly confident EU, like the EAC, enjoyed a membership spree, politically flaunting associations with Turkey and countries of Eastern Europe instead of strengthening economic policy coordination among core members.

Authorities seemed oblivious of the fact that members had lost key instruments of monetary policy.

Without the opportunity to depreciate the national currency in times of shocks, an external crisis in a common currency area that has little in cross-border adjustment mechanisms forces a member to default on debt or commence painful economic contraction. That is the Greek tragedy.

Economic crises

The bitter aftermaths are un-European.

Voters always suspected the elites downplayed their fears on future economic crises, the consequences to domestic sovereignty and the bills that could accrue to national taxpayers.

Voters matter in EU; they will punish politicians.

But while national horizons still tend to end at EU borders, retreat from the euro would be an economic disaster.

Member states are discovering their economies are inextricable in one monetary (and now fiscal) family.

Private and public sector fortunes are tethered more closely than the elites revealed in the rush to establish the euro, all against the eminent cautions of some thinkers.

What can EAC learn for its on-going project?

In the developing story, EAC Central Bank governors seem to dither on a key criterion—the amount of dollar reserves each country needs to keep ahead of the introduction of a single regional currency in 2012. Worry they should, very much.

Underlying the disagreements are strategic miscalculations and misinterpretations on how the proposed regional currency would work, and how it would hinge on the convergence criterion to maintain enough dollar reserves for at least six months of imports— a rule to be implemented by a regional monetary policy committee.

Would this import cover help stave off a euro-type speculative attack on the EAC‘s common currency in case one country or a number of countries ran into Greece-style crisis?

Do preparatory measures exist for labour and resource movements or automatic stabilisers among member countries of the EAC to adjust prices and costs in the event of such a hypothetical crisis?

Does any member country have the financial muscle—Kenya being the major economy among the five— to mobilise a bailout—with or without the IMF?

The answers would seem to be negative. Many other questions have no answers.

No one knows how the common currency would react to developments such as the ethnic punch-ups in Kenya in 2008; or the genocide of 1994 in Rwanda; or the exploits of the Lord’s Resistance Army in Uganda.

Other economic questions abound.

What is the consistency of the criteria with progress of economic integration and the major players in EAC

Begin with major economic disparities that contradict the reserves requirement.

Kenya has a huge fixed capital base approximated to exceed the stock held by all the other members of EAC combined.

Based on this stock, Kenya absorbs by far the largest quantities of imported inputs that go to the manufacture of the processed goods that help actualise the industrial benefits of economic integration in the region.

Kenya now commands not just EAC trade, especially on exports, but trade in Common Market for Eastern and Southern Africa (Comesa) as well.

Economic objectives

While Kenya’s reserve requirements to meet the reserves criterion of the common currency would be highly disproportionate to its economic objectives, and the objectives of economic integration, attempts to purchase the reserves from the market to meet the reserves requirement would distort what remains of the country’s troubled monetary policy.

The requirements also run counter to the global recession that has recently lowered the main categories of inflows.

These include inflows from EAC markets and overall remittances and earnings from exports and tourism.

Under the circumstances, it would pay to deepen regional consultation and reflection on the preparatory measures first; to institutionalise them in order for adjustment capacity to emerge in such a way that it would kick in and support the common currency if implemented.

The damage to EAC of a failed experiment in a common currency would be a scenario too costly to contemplate.

Dr Wagacha is an international macroeconomics consultant. (mwagacha@gmail.com)

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