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EXPERIENCES OF UGANDA IN THE IMPLEMENTATION OF CURRENCY CONVERTIBILITY

WITHIN THE EAST AFRICAN COMMUNITY

by

Charles A. Abuka PhD

Assistant Director

Research Department

Bank of Uganda

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A: MONETARY & FINANCIAL COOPERATION (ARTICLE 82 (1))

Provided for in the EAC treaty Maintain convertibility as a basis for

establishment of a monetary union Harmonize macroeconomic policies

especially exchange rate, interests rate and monetary and fiscal policies

Remove obstacles to free movement of goods, services and capital within EAC.

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MONETARY & FISCAL HARMONISATION (ARRTICLE 83 (2)) Remove all exchange restrictions on imports &

exports Maintain free market determined exchange rates and

enhance level of reserves Adjust fiscal policies & credit to government to ensure

monetary stability and economic growth Liberalize financial sectors, enhance competition and

efficiency in system Harmonize tax policies, remove tax distortions and

lead to efficient resource allocation.

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B: IS THE EAC AN OCA?

See debate in Nkenda (2001) & IMF (2004)

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IS THE EAC AN OCA?

Factor mobility Openness Product diversification Flexibility of prices and wages Similar inflation rates Similarities in Industrial structures High covariation in economic activities

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C: CONVERGENCE CRITERIA IN EAC Inflation Real GDP growth Current account sustainability Budget deficit National savings Foreign exchange reserve cover Market determined interest rates Market determined exchange rates Debt sustainability

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D: CURRENCY CONVERTIBILITY

An integral part of monetary integration Ability to freely exchange the local

currency into any foreign exchange at any given rate.

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CURRENCY CONVERTIBILITY

Convertibility in practice implies freedom from exchange controls.

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CURRENCY CONVERTIBILITY

Agreements exist in EAC for full convertibility for foreign exchange transactions.

Full convertibility in the EAC is a key element of monetary union.

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CURRENCY CONVERTIBILIY

An initial step to gradual elimination of exchange risk in EAC.

Crucial step in lowering cost of cross border business

Individuals benefit from knowledge of existing exchange rate and that their currency will not be rejected when traveling in the region

Business benefits from the transparency associated with transferring funds in the region

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CURRENCY CONVERTIBILIY

Easier cross border comparison of prices of goods and services should lead to increased trade.

Critical step in improving the payment system for goods and services.

Reduces transactions costs and encourages competition.

Currency convertibility is a first step to overcoming obstacles created by relatively small individual domestic markets.

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CURRENCY CONVERTIBILITY

Currency convertibility in EAC dates back to 1995 when Governors agreed to allow free convertibility.

Modalities for repatriation of excess holdings of local currencies were worked out.

The Governors meeting on 25 October 1996 made central banks buyers and sellers of last resort to inspire confidence.

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E: GUIDE ON CONVERTIBILITY

The institutional and operational framework

Visibility of exchange rates-All dealers to quote currencies of Kenya, Uganda and Tanzania alongside other foreign currencies

EAC Currencies to be competitively traded like any other foreign currencies

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GUIDE ON CONVERTIBILITY

Settlement modalities Commercial banks to open and

maintain in their books EAC currency Shilling accounts for their own accounts and for their customer

Commercial banks to establish correspondent relationships with banks in Kenya, Uganda and Tanzania.

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GUIDE ON CONVERTIBILITY

Commercial banks to be responsible for the repatriation of surplus partner currencies to their correspondent banks for the credit of their accounts

Commercial banks with no correspondent banks would be assisted in repatriation on a collection basis by the central banks at a fee.

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F: Experience with the convertibility arrangement 1998 to 2005

Mixed progress in attainment of macroeconomic convergence

Acceptance of each others currency facilitated flow of trade & investment

Convertibility has been an important avenue for promoting regional cooperation

Regional Governors have continued to interact regularly

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Experience with the convertibility arrangement 1998 to 2005

Authorized dealers in all the EAC countries are expected to quote the three regional currencies

Trading is effected all EAC currencies. Kenya shilling is the most widely traded

Magnitude of pressures on the exchange rates of EAC countries has declined over the recent years and so has the volatility of exchange rates.

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EXPERIENCE WITH CONVERTIBILITY ARRANGEMENT

The coefficient of variation of average monthly exchange rates of EAC countries vis-à-vis the U.S Dollar has declined over 2000 to 2005 period.

Relative stability of bilateral exchange rates is reflected by the fact that the fluctuations have stayed within a narrow 2- % margin.

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Table 2: EAC: Variability of Exchange rates (Against the US$ monthly data; 1980-2003)

Country/ Period Standard deviation Mean Coefficient of

variation Kenya 1980-2003 25.8 39.4 0.65 1980-1990 4.5 15.0 0.30 1990-2000 17.3 51.9 0.33 2000-2003 1.7 77.8 0.02 Tanzania 1980-2003 342.7 370.6 0.92 1980-1990 62.0 54.9 1.13 1990-2000 198.7 509.4 0.39 2000-2003 75.1 956.2 0.08 Uganda 1980-2003 678.9 742.7 0.91 1980-1990 133.4 75.3 0.77 1990-2000 321.1 1082.6 0.30 2000-2003 97.0 1837.5 0.05 Source: IMF study on monetary union among EAC countries

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Table 3: EAC: Variability of bilateral nominal exchange rates (monthly data; 1980-2003)

Bilateral rate between Kenya and Tanzania (K Shs/T Shs) Standard

deviation Mean Coefficient

of variation

1980-2003 0.42 0.37 1.12 1980-1990 0.43 0.69 0.63 1990-2000 0.02 0.08 0.24 2000-2003 0.01 0.08 0.09 Bilateral rate between Kenya and Uganda (K Shs/ U Shs) 1980-2003 23.85 7.55 3.16 1980-1990 33.16 16.42 2.02 1990-2000 0.01 0.05 0.19 2000-2003 0.00 0.04 0.07 Bilateral rate between Tanzania and Uganda (T Shs/ U Shs)

1980-2003 25.38 8.24 3.08 1980-1990 35.43 17.40 2.04 1990-2000 0.11 0.47 0.24 2000-2003 0.03 0.52 0.05 Source: IMF study on monetary union among EAC countries

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Table 4: EAC: Variability of bilateral real exchange rates (monthly data; 1980-2003)

Bilateral rate between Kenya and Tanzania (K Shs/T Shs) Standard

deviation Mean Coefficient

of variation 1990-2000 1.46 4.68 0.31 2000-2003 0.73 10.02 0.07 Bilateral rate between Kenya and Uganda (K Shs/ U Shs) 1990-2000 0.97 5.94 0.16 2000-2003 0.28 4.37 0.06 Bilateral rate between Tanzania and Uganda (T Shs/ U Shs) 1990-2000 16.00 65.70 0.24 2000-2003 1.99 43.67 0.05 Source: IMF study on monetary union among EAC countries

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G: The Ugandan market

Gross transactions have risen by more than six fold from 1998 to 2004.

Ken Shs. traded rose from Shs 0.535 bn. to Shs. 3.897 bn.

Tz Shs. traded rose from Shs. 1.035 bn to Shs. 7.819 bn.

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Volume of Kenya currency traded in the Bureax

268.46479.88

645.80665.96

977.73

2,686.21

1,732.19

266.17472.77

632.52689.38

971.61

2,700.60

1,711.12

534.63

952.65

1,278.321,355.34

1,949.34

5,386.81

3,443.30

0.00 2,000.00 4,000.00 6,000.00 8,000.00 10,000.00 12,000.00

1998

1999

2000

2001

2002

2003

2004

Per

iod

Millions of Shillings

Purchases Sales Gross

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Volume of Tanzanian currency traded in the Bureaux

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

20000

Millio

ns o

f Sh

illing

s

1998 1999 2000 2001 2002 2003 2004

Period

Purchases Sales Gross

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H: EARLY ISSUES WITH CONVERTIBILITY

Initial evidence of arbitrage for other EAC currencies Large spreads between buying and selling rates for some

currencies Impact of the transactions charge on repatriated funds. Public awareness of the convertibility arrangement. Costs involved in fund repatriation by commercial banks. Differences in external openness in EAC. Trade imbalances. Regional FDI

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ISSUES WITH CONVERTIBILITY

Differences in export structures and degree of diversification in production structures

All three countries still trade mainly with non-EAC countries.

For exports, Kenya has the largest share of the regional market. Its regional exports are much less than those outside the region

For imports Uganda has the largest share of imports originating from the region, Tanzania follows and Kenya has the least.

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Table 1: Trade indicators for the East African Community countries Kenya Tanzania Uganda Memorandum item

1990 2003 1990 2003 1990 2003 Two main exports as a % of total exports 37.7 32.4 9.3 53.0 75.0 32.8 Exports of gds & servs % of GDP 26.9 25.4 11.5 11.2 9.5 8.0 Imports of gds & servs % of GDP 28.5 30.1 29.0 20.1 29.6 27.2 Openness 55.4 55.6 40.5 31.2 39.1 39.9 Shares of bilat trade with 2 other countries in total trade

7.0 10.7 2.2 6.2 30.1 36.5

CAB excl. transfers, % of GDP -11.0 -8.6 -18.9 -8.9 -8.1 -10.8

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Direction of Uganda’s exports in 2004

36.9

27.39.81.7

7.1

35.8

European Union Comesa Kenya Tanzania Rest of Africa Others

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Source of Uganda’s imports in 2004

European Union, 18.9

Comesa, 25.6

Kenya, 22.6Tanzania, 0.9Rest of Africa, 8.7

Others, 55.5

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I: THE FUTURE OF CONVERTIBILITY IN THE EAC

Macroeconomic convergence to support a degree of stability in bilateral exchange rates of East African countries

Policies to improve the EAC economies, increase stability and strengthen their capacity to absorb socks

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THE FUTURE OF CONVERTIBILITY IN THE EAC

Strengthening of institutions to ensure the adoption and coordinated implementation of appropriate monetary and exchange rate policies.

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THE FUTURE OF CONVERTIBILITY IN THE EAC

Free market determined exchange rates will be maintained

Existing convertibility of EAC currencies will be maintained

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THE FUTURE OF CONVERTIBILITY IN THE EAC

Measures to facilitate trade and capital movements within the community will be enhanced

Development, harmonization and integration of financial systems in the EAC

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THE FUTURE OF CONVERTIBILITY IN THE EAC

Continue to strengthen the institutional and operational arrangements for greater convertibility.– Technology for productivity and efficiency

of settlement arrangements: minimize risks to convertibility.