The topic of the joint Country Session of Rwanda and Tanzania was 'Toward Monetary Union in East Africa'. It focused on the progress and challenges of progress towards creating an East African monetary union. The presentations in this slideshare are from Christopher Adam and Dick Durevall.
Growth Week 2011: Joint Country Session – Rwanda/Tanzania
1. Tanzania: Fiscal Challenges
IGC Growth Week, 20 September 2011
Christopher Adam – Oxford and IGC
Stephen A. O’Connell (Swarthmore)
Peter J Montiel (Williams)
2. Fiscal Tensions
Unwinding ESF / Action Plan
• Deteriorating external conditions –food and fuel prices
• Declining donor flows
• ‘Flattening’ revenue mobilization
• => need for fiscal consolidation
Expenditure priorities (TNDV2025)
• Demographic pressures on recurrent budget
• Meeting current MDG obligations
• Recurrent implications of public investment
Key question
• How much fiscal space?
3. Tanzania: Government Operations and Financing
2001-2012
Total Expenditure and Net Lending Domestic Revenue
Grants Net Foreign Financing
Net Domestic Financing
35%
30%
25%
20%
15%
10%
5%
0%
2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11p 2011/12b
3
-5%
5. Fiscal sustainability
• Growth in recurrent spending is worrisome when projected into the future
only to the extent that such spending is not productive and is not offset
elsewhere by reductions in unproductive development spending or by
increased revenues.
• How much of the recent stagnation in the revenue-to-GDP ratio is due to
the effects of the international recession and to purposive countercyclical
measures on the part of the government?
• What prospects are there for raising the revenue ratio, through tax
reforms and increased administrative measures, and what constitutes an
appropriate level of ambition on enhancing tax effort?
6. Fiscal sustainability
• How does donor fiscal stringency on prospective aid flows?
• Do the favorable terms Tanzania is currently able to secure on non-
concessional borrowing reflect the continued engagement of donors?
• If so, a contraction in donor flows may see the cost as well as the volume
of non-concessional financing rise, requiring a sharper fiscal adjustment.
• To the extent that continued donor engagement is influenced by concerns
on fiscal performance, the balance of effort should be towards enhanced
domestic revenue mobilization and improved expenditure efficiency
rather than achieving deficit reduction by cutting back on productive
recurrent expenditures.
7. Recurrent cost implications: some back of the
envelope calculations
• Public Output : Q = Lθ K 1−θ
• Cost of labour per unit of public capital:
wL / K
=incremental cost of labour per unit of public investment for K/L unchanged.
Re-write : wL wL
= .(r + δ )
•
K (r + δ ) K
• Note wL θ
= ≈ 1.5
(r + δ ) K 1 − θ
If r + δ ≈ 0.10 => recurrent cost is 15 percent per dollar; at gross return of
0.20 the recurrent cost is 30 percent per dollar. Current fiscal arithmetic tends to book
depreciation costs only +/- 5% per annum.
8. East African Community: Pre-conditions
for an effective monetary union
Dick Durevall
International growth Centre and University of
Gothenburg
9. Outline
Four types of pre-conditions
Current economic structure (Optimum Currency
Area arguments)
Political and institutional pre-conditions
Convergence criteria
Fiscal policy rules
Conclusion
10. Current economic structure
Monetary stability (see Figure 1)
Governments have a history of weak monetary discipline
Asymmetric shocks (Figure 2 and 3)
Agricultural supply and terms of trade shocks
The importance of exchange rate flexibility?
Regional and international trade integration
Transaction costs
Financial Integration
Structural divergence
14. Political and institutional
pre-conditions
Political will to form a monetary union crucial
Need for supranational institutions
Require political will and needed when will is failing
Legitimacy and acceptance of supranational institutions
Institutional preparation
Prepare and ratify necessary legal instruments and set up institutions
such as the East African Monetary Institute (EAMI)
Carry out technical preparatory work to create the operational and
regulatory foundation for EAMU.
Customs Union ‘completed’ in 2010, Common Market in 2015.
ECB (2010) report on EAMU: a lot of work is needed before it
can be established
15. Convergence criteria
Stage II (2011-2014)
Primary Criteria
a) Overall Budget Deficit to GDP Ratio (excluding grants) not exceeding 5%; and Overall
Budget deficit to GDP Ratio (including grants) not exceeding 2%;
b) Annual Average Inflation Rate of not more than 5%;
c) External Reserves of more than 6 months of imports of goods and non-factor services.
Secondary Criteria
a) Maintenance of Market Based Interest Rates;
b) Maintenance of high and sustainable rate of real GDP growth of not less than 7.0%;
c) Sustained pursuit of debt sustainability;
d) Domestic Savings to GDP Ratio of at least 20%; and
e) Maintenance of sustainable level of Current Account Deficit (excluding grants) as % of
GDP.
16. Convergence criteria
Several problems with the criteria
Definitions and measures not defined (prices, dates, sustainability)
Too ambitious and not under the control of government (7% GDP
growth)
Inconsistent (budget deficits with a without grants)
Use of absolute levels instead of relative levels (5% inflation)
The EAC has a criterion for the real exchange rate in Stage I; but
there is no criterion for nominal exchange rates, and nothing in Stage
II.
Risk of costly short-term adjustment when EAMU formed
Key issue for EAMU is the credibility of the monetary policy
framework adopted by the EACB, and not big adjustment after
unification.
17. Fiscal policy rules
Fiscal policy and free-rider problem
Without rules, fiscal policy is too expansionary
Bailout, risk of bailout, and high inflation due to deficits
Controversial issue, but not any longer
Beetsma and Giuliodori (2010) conclude there is a rationale for fiscal
constraints
Public debt and fragility of monetary unions
De Grauwe’s example, Spain and the UK
How to design fiscal policy rules (without political union)
Must allow for countercyclical fiscal policy
Must allow for external shocks
How to enforce the rules
How to impose sanctions without worsening the debt
Suggestions: mechanic sanctions and stabilization fund, joint issue of
Eurobonds, (national) rules for balanced budget over business cycle,
independent fiscal policy authority, etc
18. Conclusion
Many potentially positive effects of a monetary union
Rwanda, a small landlocked country, should benefit
Major risks
Political will might be lacking in practice
Inadequate implementation and weak central bank
Short-run costs might generate discontent and public protest
Large political changes/upheavals
Cost of loss of exchange rate flexibility?
Much work is needed to develop
supranational institutions to enforce decisions
legal framework and an institutional structure specifically for the
monetary union
sensible convergence criteria (exchange rates, budget deficits)
fiscal policy rules
19. Table 1. Indicators of economic
structure
Kenya Rwanda Tanzania Uganda Burundi
GDP per capita (current US$) in 2010 767 548 527 503 189
GDP per capita, PPP (current international $) in 2010 1621 1194 1423 1249 399
Industry, value added (% of GDP) in 2009 15.3 14.5 24.3 25.8
Manufacturing, value added (% of GDP) in 2009 8.7 6.4 9.5 8.0
Agriculture, value added (% of GDP) in 2009 22.6 34.2 28.8 24.7
Services, etc., value added (% of GDP) in 2009 62.1 51.3 46.9 49.5
Trade (% of GDP) in 2010 63.5 40.9 58.4 58.0 57.7*
Note: The source is World Development Indicators. * measured in 2006.