1. 1 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

2. 2 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.

3. 3 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.

4. 4 B: IS THE EAC AN OCA? See debate in Nkenda (2001) & IMF (2004)

5. 5 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

6. 6 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

7. 7 D: CURRENCY CONVERTIBILITY An integral part of monetary integration Ability to freely exchange the local currency into any foreign exchange at any given rate.

8. 8 CURRENCY CONVERTIBILITY Convertibility in practice implies freedom from exchange controls.

9. 9 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.

10. 10 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

11. 11 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.

12. 12 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.

13. 13 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

14. 14 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.

15. 15 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.

16. 16 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

17. 17 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.

18. 18 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.

19. 19 Table 2: EAC: Variability of Exchange rates (Against the US$ monthly data; 1980-2003)

20. 20 Table 3: EAC: Variability of bilateral nominal exchange rates (monthly data; 1980-2003)

21. 21 Table 4: EAC: Variability of bilateral real exchange rates (monthly data; 1980-2003)

22. 22 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.

23. 23 Volume of Kenya currency traded in the Bureax

24. 24 Volume of Tanzanian currency traded in the Bureaux

25. 25 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

26. 26 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.

27. 27

28. 28 Direction of Uganda’s exports in 2004

29. 29 Source of Uganda’s imports in 2004

30. 30 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

31. 31 THE FUTURE OF CONVERTIBILITY IN THE EAC  Strengthening of institutions to ensure the adoption and coordinated implementation of appropriate monetary and exchange rate policies.

32. 32 THE FUTURE OF CONVERTIBILITY IN THE EAC Free market determined exchange rates will be maintained Existing convertibility of EAC currencies will be maintained

33. 33 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

34. 34 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.