Income Convergence in the East African Community

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Date
2018-01Author
Githuku, Simon
Omolo, Jacob
Mwabu, Germano
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The East African Community partner states aim to establish a Monetary Union by 2023. As
advanced by the optimum currency area theory, countries seeking to enter into a monetary union
should be as similar as possible to reduce their susceptibility to adverse economic shocks. The
East African Monetary Union Protocol signed in 2013 stresses the need for convergence of
macroeconomic variables as important preconditions before forming the monetary union. The
benchmark macroeconomic indicators include a headline inflation rate of eight per cent, a fiscal
deficit of three per cent of the country’s gross domestic product on net present value terms, a
debt to gross domestic product ratio of 50 per cent and maintenance of a 4.5 months’ reserves of
import cover. Article 82 (1) of the East African Community Treaty also compels partner states to
work towards harmonizing their macro-economic policies especially those related to interest and
exchange rates, fiscal and monetary policies. However, as argued by many scholars, nominal
convergence alone cannot indicate how well countries will perform once they are in a monetary
union. The criteria also fail to distinguish the countries that constitute an optimal currency area.
An autoregressive distributed model was applied in regression analysis. Empirical findings
supported the presence of conditional convergence and that per capita gross domestic product
growth was positively influenced by physical capital and nominal exchange rate depreciation and
negatively affected by human capital and inflation rate. From the foregoing, it can be concluded
that reduction of income differences among the partner states can be fostered through increased
investments in physical capital, maintenance of a competitive exchange rate regime and a low
inflation rate regime.