Transmission Mechanisms and Macroeconomic Convergence Within the East African Community

Abstract

The East African Community had set to achieve macroeconomic variables convergence by specific timelines to open way for the formation of a monetary union, which have never been realized even after numerous timelines. Member states continue experiencing slow Gross Domestic Product growth rates, persistent high inflationary and unemployment trends, and low intra-trade within the region due to high transaction costs, currency conversion risks and costs, and long bureaucratic payment procedures. These continue to negate the spirit inherent in the custom union and common market protocols that are already in place. Hence, the need to investigate the macroeconomic variables and establish their trends in comparison to the targets that had been set to realize the convergences and subsequent adoption of a monetary union. The conceptualization of this thesis was anchored on three objectives. The first objective was to establish if the East African Community has been able to realize convergence in their macroeconomic policies as a prerequisite requirement for the inception of a regional currency union to stimulate economic growth. The second objective sought to establish if the monetary policy transmission channels used individually by the Partner States are converging to the extent that would lead to a conclusion that the monetary policies adopted in the region are geared towards the desired objective of forming the monetary union. The third objective assessed if the convergence criteria adopted by the Community are either backed by the real market data in the region or not. Customs Unions, Common Markets, and Monetary Unions have proved beneficial in regional blocs where they have been well established. Hence, East African Community is not an exception in their determination to set up for the monetary union path. The economic union is beneficial in promoting trade, removal of currency conversion bottlenecks, making transaction costs significantly reduced, besides making payment procedures less bureaucratic. Therefore,

what was critical at this stage and of great interest was to measures the achievement levels of the convergences established by the Partner States; that is, by the joint East Africa Monetary Committee aimed at the realization of the intended goal of forming the monetary union. Five East Africa member states were considered in the study, Kenya, Uganda, Tanzania, Rwanda, and Burundi. In answering the first objectives, the study employed panel data spanning the years 2008 to 2018 and adopted Sigma convergence, Beta convergence, stochastic convergence and Co-integration testing techniques. The results showed no evidence for macroeconomic convergence and that Rwanda, Uganda, and Burundi are not getting any closer to their counterparts Kenya and Tanzania whose economies are bigger. However, similar to what the convergence framework predicts, the macroeconomic variables are generally moving in the same direction, albeit in slow rate, which signifies good hope for long-term convergence, although not in the near future. Therefore, the East African Community must create strategies to ensure that the member states implement policy efforts that would drive the region towards mutual convergence to be able to achieve the monetary union goal. The second objective aimed to test the stability of the East African monetary transmission mechanism channels of interest rates and exchange rates, and analysed the effect of interest rate and exchange rate on economic growth within the East African Community. Fixed effect, Unit-root test, Co-integration tests, and Sigma convergence tests were adopted in answering the second objective of the study. The finding showed stability in interest rates but volatility in exchange rates. The analysis also indicated the absence of convergence in the short-run for the exchange rates but the presence of convergence in interest rates. Nevertheless, there were indications of co-integration of the two variables of the monetary policy in the long run. This shows that the financial sector is doing well in the road map towards the formation of the monetary union. Interest rate was found to positively influence economic growth while exchange rate had a negative impact on growth. Thus, the East African Monetary Committee

should consider enforcing implementation of an exchange rate regime that can register sustained economic progress and achievement of the desired convergence. For the third objective, the study adopted Dynamic Threshold analysis technique. The finding showed a slight variation between the thresholds supported by data and the set thresholds by the East African Monetary Committee. The set thresholds lie within close range of the market thresholds, but they are more stringent, such that there is room for flexibility that can be adopted to enable the region to realize its desired objective of a monetary union much faster. The study recommended for the East African Monetary Committee to review its stance on the desired fiscal and monetary policies and the thresholds that member countries must attain for them to join the ultimate monetary union. There should also be a deliberate effort to review the fiscal and monetary policies instituted as the irreducible for the members to join the monetary union. For these to be achieved, there is need for strengthened unison, coordination and enforcement of regulations for the objective of a monetary union to be realized sooner.