Opinion / Columnist
Initiation of SADC economic working group a welcome development
06 Oct 2015 at 11:26hrs | Views
The on-going discussion by SADC to form an economic working group is a rational economic move which is poised to transform the regional economic fortunes. As regional economic communities (RECs) strive to deepen their level of integration, an increasing number are considering forming a monetary union. SADC member states have expressed the objective of attaining a full economic union to enhance, monetary and fiscal integration in the whole region.
In the Southern African context, the Southern African Development Community (SADC) has established a framework for outlining procedures and milestones that need to be realized for achieving the necessary macroeconomic convergence for a unified Common Monetary Area (CMA). This form of monetary union is already active in the Southern African Customs Union (SACU), which maintains national currencies but has a unified monetary policy that is pegged to a regional anchor currency.
Studies have been conducted on the benefits of a monetary union and the use of currency areas in Africa, but little work has been done on the readiness of SACU for a monetary union, assuming it decided to upgrade the CMA. Monetary unions limit the capacity of individual states to manage their own financial affairs by centralizing monetary policy, and as such a union without convergence can give rise to inappropriate policies and expose countries to damaging idiosyncratic shocks.
There is increasing economic debate on the benefits and costs of such an arrangement. In a CMA, there exists a de facto or anchor currency that is accepted as a medium of exchange within the monetary area. This anchor currency is accompanied by rules that govern a CMA's operations, such as limiting the mandate of local central banks within a CMA, notably the financing of fiscal deficits through monetary expansion, so-called quantitative easing; maintaining sound macro-economic performance; and uniform guidelines for prospective and existing members.
Other rules relate to the governance of inflation rates, both current and expected and keeping a CMA's internal exchange rates within the margins of the de facto currency. Debates continue about the possibility of extending these rules to regulate deficits and debt, and on how to vary deficit ceilings along the business cycle. Decision making under a CMA is therefore constrained by both the rules and reliance on the anchor currency. Although there are often mechanisms to promote consultation among member states, a central bank or currency board, in particular the central bank of the member state with the anchor currency becomes the primary decision-making organ.
There are key decision-making processes and functionalities of a CMA. Small CMA member countries have a right to issue national currencies through their respective central banks. Currencies of CMA member countries and the anchor currency are the only legal tender for the respective member countries.
Central banks of CMA member states are required to maintain foreign reserves at least equal to their total local currencies in circulation.
There are no restrictions on the transfer of funds, except for liquidity requirements for financial institutions. CMA member states are free to invest in the dominant country's capital and monetary markets through specified securities.
There are exchange control regulations that govern the issuing and receipt of gold and foreign exchange by authorized dealers in the CMA. The dominant country compensates the smaller countries for their forgone seigniorage, given that the smaller countries' currencies are not legal tender in the wider CMA.
There is a commission with equal representation from CMA member states consisting of technocrats and monetary authorities. The commission holds regular consultative meetings to discuss and reconcile member states' monetary and foreign-exchange policy interests. Besides the commission, there is a tribunal that arbitrates disputes arising from CMA implementation.
Indicative Strategic Development Plan sets out a target to realize a SADC monetary union by 2016 and a common currency by 2018. This seems ambitious, given the frameworks and institutions that are required for a monetary area operation.
Even if this timeframe was feasible, there remains uncertainty as to whether the benefits of deeper monetary integration outweigh the costs. Linking a local currency to an anchor currency can improve macro-economic stability as opposed to operating under a flexible exchange rate.
Under a flexible exchange rate regime, commodity prices often become unstable, and can in turn create disturbances in smaller SADC economies, particularly if their currencies are depreciating; thereby resulting in general price-level volatility. However, although a CMA would have a better capacity to cope with these disturbances, it would have less capacity to deal with the idiosyncratic shocks and development challenges that might only occur in certain member states, which would have lost their capacity to tailor monetary policy to their needs through the centralization of monetary control.
Individual countries could face the effects of differentiated external shocks due to differences in their production, consumption and expenditure patterns; market characteristics (monopolistic/competitive); and level of openness, among others. Asymmetric shocks could cause havoc to individual economies under independent currencies.
The benefits and costs of a common currency includes tying domestic inflation to partner's inflation or targeted currency area inflation rate, establishes an anchor for monetary policy and imports credibility. It decreases transaction costs as well as improves microeconomic efficiency by increasing price transparency between partners. It also eliminates costs associated with exchange rate uncertainty vis-à-vis partner countries, for instance hedging.
It creates room to reduce the risk premium on interest rates in the home country – currency and inflation risk and it can be a catalyst for further economic integration, endogeneities.
If we look at Zimbabwe's background during the hyper-inflation times, this concept protects against domestic lobbies promoting exchange-rate manipulation, and reduces risk of speculative attack on home country currency. The rate at which the local currency lost value will certainly be averted and keep regional economies on track and eventually lead to growth and development.
In the Southern African context, the Southern African Development Community (SADC) has established a framework for outlining procedures and milestones that need to be realized for achieving the necessary macroeconomic convergence for a unified Common Monetary Area (CMA). This form of monetary union is already active in the Southern African Customs Union (SACU), which maintains national currencies but has a unified monetary policy that is pegged to a regional anchor currency.
Studies have been conducted on the benefits of a monetary union and the use of currency areas in Africa, but little work has been done on the readiness of SACU for a monetary union, assuming it decided to upgrade the CMA. Monetary unions limit the capacity of individual states to manage their own financial affairs by centralizing monetary policy, and as such a union without convergence can give rise to inappropriate policies and expose countries to damaging idiosyncratic shocks.
There is increasing economic debate on the benefits and costs of such an arrangement. In a CMA, there exists a de facto or anchor currency that is accepted as a medium of exchange within the monetary area. This anchor currency is accompanied by rules that govern a CMA's operations, such as limiting the mandate of local central banks within a CMA, notably the financing of fiscal deficits through monetary expansion, so-called quantitative easing; maintaining sound macro-economic performance; and uniform guidelines for prospective and existing members.
Other rules relate to the governance of inflation rates, both current and expected and keeping a CMA's internal exchange rates within the margins of the de facto currency. Debates continue about the possibility of extending these rules to regulate deficits and debt, and on how to vary deficit ceilings along the business cycle. Decision making under a CMA is therefore constrained by both the rules and reliance on the anchor currency. Although there are often mechanisms to promote consultation among member states, a central bank or currency board, in particular the central bank of the member state with the anchor currency becomes the primary decision-making organ.
There are key decision-making processes and functionalities of a CMA. Small CMA member countries have a right to issue national currencies through their respective central banks. Currencies of CMA member countries and the anchor currency are the only legal tender for the respective member countries.
Central banks of CMA member states are required to maintain foreign reserves at least equal to their total local currencies in circulation.
There are no restrictions on the transfer of funds, except for liquidity requirements for financial institutions. CMA member states are free to invest in the dominant country's capital and monetary markets through specified securities.
There are exchange control regulations that govern the issuing and receipt of gold and foreign exchange by authorized dealers in the CMA. The dominant country compensates the smaller countries for their forgone seigniorage, given that the smaller countries' currencies are not legal tender in the wider CMA.
There is a commission with equal representation from CMA member states consisting of technocrats and monetary authorities. The commission holds regular consultative meetings to discuss and reconcile member states' monetary and foreign-exchange policy interests. Besides the commission, there is a tribunal that arbitrates disputes arising from CMA implementation.
Indicative Strategic Development Plan sets out a target to realize a SADC monetary union by 2016 and a common currency by 2018. This seems ambitious, given the frameworks and institutions that are required for a monetary area operation.
Even if this timeframe was feasible, there remains uncertainty as to whether the benefits of deeper monetary integration outweigh the costs. Linking a local currency to an anchor currency can improve macro-economic stability as opposed to operating under a flexible exchange rate.
Under a flexible exchange rate regime, commodity prices often become unstable, and can in turn create disturbances in smaller SADC economies, particularly if their currencies are depreciating; thereby resulting in general price-level volatility. However, although a CMA would have a better capacity to cope with these disturbances, it would have less capacity to deal with the idiosyncratic shocks and development challenges that might only occur in certain member states, which would have lost their capacity to tailor monetary policy to their needs through the centralization of monetary control.
Individual countries could face the effects of differentiated external shocks due to differences in their production, consumption and expenditure patterns; market characteristics (monopolistic/competitive); and level of openness, among others. Asymmetric shocks could cause havoc to individual economies under independent currencies.
The benefits and costs of a common currency includes tying domestic inflation to partner's inflation or targeted currency area inflation rate, establishes an anchor for monetary policy and imports credibility. It decreases transaction costs as well as improves microeconomic efficiency by increasing price transparency between partners. It also eliminates costs associated with exchange rate uncertainty vis-à-vis partner countries, for instance hedging.
It creates room to reduce the risk premium on interest rates in the home country – currency and inflation risk and it can be a catalyst for further economic integration, endogeneities.
If we look at Zimbabwe's background during the hyper-inflation times, this concept protects against domestic lobbies promoting exchange-rate manipulation, and reduces risk of speculative attack on home country currency. The rate at which the local currency lost value will certainly be averted and keep regional economies on track and eventually lead to growth and development.
Source - Suitable Kajau
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