An economic analysis of the feasibility of a monetary union in two African economic regions: SADC and EAC
Redda, Ephrem Habtemichael
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The Association of African Central Bank Governors, in 2003, announced that it would work for a single currency and common central bank by 2021. Many regional trading blocs and economic communities in Africa including SADC and EAC are working towards this grand objective. As advocated by the optimal currency area (OCA) theory, lower transaction costs, stable prices, efficient resource allocation and improved access to goods, labour and financial markets are some of the benefits accrued from monetary unions. Relinquishing monetary and exchange rate policies are cited as the main costs of joining a monetary union. Forming a monetary union is a serious endeavour by any stretch of imagination that needs serious and deliberate consideration. It could have a devastating impact on the continent and may even worsen the socio-economic conditions of the people if it is not based on sound economics, therefore, serious consideration ought to be given to such a decision. In light of this problem statement, the primary objective of this study was formulated to analyse the feasibility of a monetary union in two African economic regions, namely SADC and EAC, in the envisaged time frame. Literature on feasibility of monetary unions is dominated by the OCA theory and setting certain crucial macroeconomic convergence criteria (MECC). The study employed two separate but complimentary methodologies to realise its objectives. Descriptive statistics such as the mean, standard deviation, skewness and kurtosis were utilised in assessing the feasibility of a monetary union in the two economic regions with regard to the MECC. Various analysis such as descriptive statistics, correlation analysis, Granger causality test, Johansen cointegration test and panel cointegration test were computed in assessing the feasibility of a monetary union in respect of OCA. The MECC analysis included inflation rate, budget deficit, government debt as a percentage of GDP, total reserves cover and GDP growth. Of the 14 countries in the SADC region, only eight countries were able to meet the inflation rate criterion, six countries the budget deficit, 10 countries the government debt, only one country foreign reserve requirement and none of the countries achieved the GDP growth rate criterion during the assessment period (year 2015). In the EAC region, out of five countries, only one country achieved the inflation rate criterion, while three countries the budget deficit criterion during the assessment year. All five members achieved the government debt requirement. However, none of the countries in the EAC region could achieve the foreign reserve requirement nor attain the required economic growth. Briefly, the analysis of the five macroeconomic variables of both economic regions suggests that member countries have serious challenges in meeting the macroeconomic convergence criteria. Furthermore, the analysis indicates that member countries are not at par with each other with regard to macroeconomic convergence criteria. This issue was more prevalent in the SADC region than the EAC region. Therefore, the study, based on the MECC, concludes that the said monetary union in both SADC and EAC is not feasible, at least in the envisaged timeframe. In accordance with OCA theory, degree of openness of the economies, synchronisation of business cycles and the generalised purchasing power parity (GPPP) were analysed for the two economic regions. In terms of trade openness, there is clear indication that, generally, most of the SADC countries are open to external trade, meeting the requirement of the OCA theory in this regard. This may mean that they stand to benefit from adopting a common currency in as far as trade openness is concerned. While the countries in the EAC region have shown some progress in opening up their economies somewhat in the last 30 years, none of them has attained the required criterion. The evidence from this analysis suggests that the countries in the EAC region may not stand to benefit from adopting a common currency. The results of correlation analysis and Granger causality test indicate that both economic regions lack business cycle synchronisation, therefore, do not constitute monetary areas. On the positive side, the analysis of the GPPP indicates that GPPP holds in two economic regions. Trace statistic and Max-Eigen statistic confirm that there is at least one cointegrating equation indicating long-run association of real exchange rates in the SADC region. The presence of cointegrating vector(s) is supportive of an OCA and can be interpreted as similarities of fundamental macroeconomic factors that derive real exchange rate in the region. The result also suggests the countries share similar real disturbance in as far as real exchange rate is concerned. This means the bilateral real exchange rate in the SADC and EAC region share a common stochastic trend in the long run. This evidence suggests that the two economic regions constitute an OCA. This finding also was supported by Pedroni’s panel cointegration test. The overall weight of evidence based on the MECC and OCA theory suggests that the proposed monetary unions in the SADC and EAC are not feasible in the envisaged timeframe. By establishing the feasibility of monetary union in the two economic regions, the study attempts to make modest contribution to the debate on possible economic and monetary union in Africa and particularly in those two African economic regions. Furthermore, the study seeks to assist and advise policy makers in their decisions - decisions that will affect millions of people across the continent. Among other things, the two economic regions need to increase macroeconomic coordination with regard to fiscal, monetary, trade and exchange rate policies is crucial in converging and smoothing asymmetries ahead of possible full-fledged monetary union in the future.