Regional integration continues towards the goal of a common market

Kenya’s economy is partly tied to those of its neighbours through their shared history, its role as a port to serve landlocked countries to the west and north, and its membership in the East African Community (EAC). This is a regional integration organisation with an ambitious agenda including common markets, a common currency and ultimately a single federated state comprising the current five sovereign members.

One of the driving ideas behind integration is that together these countries present a larger and more attractive market for foreign investors. The region currently has a population of 140m and a GDP that surpasses $100bn. EAC countries averaged 6.1% GDP growth in 2013, up from 5.3% in 2012, according to the Kenya National Bureau of Statistics. Inflation has been falling across the zone, from 11.5% in 2012 to 6.9% in 2013. The EAC countries are net importers, and as a region the current account deficit widened to 12.7% in 2013 from 12.4% the previous year.

History Of Cooperation

Kenya is also a member of another regional integration organisation, the Common Market for Eastern and Southern Africa (COMESA). And efforts at banding together date back further than independence: Kenya and Uganda established a Customs union in 1917, for example. An initial attempt at regional integration in the post-colonial era was short-lived, with the original EAC signed into existence in 1967 and collapsing a decade later. It was revived in the 1990s by the heads of state of Kenya, Tanzania and Uganda, and the current secretariat in Arusha, Tanzania was opened in March of 1996. Negotiations on a formative treaty were concluded in 1999 and it went into force in 2000. Burundi and Rwanda joined in 2007.

Since 2001, according to the chairperson of the EAC Council of Ministers, Phyllis Kandie, who is also Kenya’s Cabinet secretary for the Ministry of East African Affairs, Commerce and Tourism, there have been 12 meetings attended by heads of state, and 121 decisions and directives resulting from them. Of that total 70 had been fully implemented as of May 2014 and 42 partially implemented.

Broadly, however, the EAC’s mission can be grouped into four major phases. The first was the Customs union protocol, which has been implemented. Second came the common market protocol, which entered into force in July 2010 but in practice will take until 2015 for full compliance. Longer-term goals are monetary union, now set for 2024, and integrating into a single federated state.

“The implementation of these initiatives is far from complete, but important progress has already been achieved,” according to an IMF report on the EAC from December 2013. “Further efforts to speed up trade liberalisation and to harmonise policies are desirable in themselves and will also help to increase the benefits of monetary union.”

Trading Regime

The Customs Union Protocol, signed in 2004, established common external tariffs and a roadmap for the gradual elimination of internal ones. Tariffs for exports into the EAC region were divided into three bands, with tax rates at 0%, 10% and 25%, respectively. Raw materials, capital goods, agricultural inputs, as well as some medicines and medical equipment were placed in the tax-free band. Semi-finished goods and industrial inputs are taxed at 10%, and finished products at 25%. Some exceptions apply, such as 31 agricultural products taxed at higher rates. Internal tariffs were phased out by 2010. The EAC’s work on tariffs has delivered the desired results. The value of intra-EAC trade more than doubled between 2005 and 2010, according to the World Politics Review, boosting internal trade to more than 10% of the total for the first time. In 2010 came the Common Market Protocol, which will ensure free movement of goods, people, labour and capital. Full compliance is expected by the end of 2015. Small traders can now apply for an EAC passport, or use national identity cards as valid documents for international travel within the zone.

Infrastructure projects and reforms in Kenya, such as efforts to reduce delays in clearing cargo at the Port of Mombasa and the development of a rail corridor between the coastal city and South Sudan and Ethiopia, should help to further boost trade within the EAC zone. For example, the latter project, the Lamu Port and Lamu Southern Sudan-Ethiopia Transport Corridor, could help stimulate economic activity in Kenya’s mostly arid and sparsely populated north. South Sudan and Ethiopia are prospective members of the EAC, along with the Democratic Republic of Congo and Somalia.

Common Currency

The move toward a single currency is guided by the EAC Monetary Union Protocol, which was signed in November 2013. The East African shilling is to be introduced by 2024 in member states that meet the convergence criteria, and an independent EAC central bank will be established, converting existing central banks to operational bodies. Called the EAC Monetary Institute, it is set to open in 2015 in order to oversee convergence efforts and preparatory work. The plan also calls for the establishment of the East African Surveillance, Compliance and Enforcement Commission by 2018, as a monitoring body for convergence. At that point the monetary and exchange rate policies of EAC members are expected to be identical.

The main convergence criteria, which are to be met for at least three years before joining the currency, are an inflation rate not exceeding 8%, a fiscal deficit of less than 3% of GDP, gross public debt at 50% or lower of GDP at net present value, and reserves sufficient to cover at least 4.5 months of imports.

According to a Central Bank of Kenya description of the process, at the preliminary stage convergence criteria have been split into primary and secondary categories. The secondary criteria serve to reinforce the primary ones. There, the standards by 2014 include maintaining market-based interest rates, achieving sustainable GDP growth rates of at least 7%, reaching a domestic savings-to-GDP ratio of at least 20% and maintaining a stable current account deficit. For the latter there is no numerical threshold. To date EAC members have been lagging these indicators, although Kenya plans to meet the criteria earlier than 2024, pledging a debt-to-GDP ratio of 40% by fiscal year 2017/18 and a deficit at 3%.

In 2013 the East African Cross Border Payment System was implemented, providing a real-time multi-currency platform for payment settlements. It is operational thus far in Kenya, Tanzania and Uganda, and Rwanda and Burundi are preparing their national systems to join. Central bankers have also been increasing their degree of coordination on several levels in recent years. For banks with operations in multiple EAC markets, on-site inspections are conducted with a regulator from each of the countries present. Kenya has also opted to join COMESA’s Regional Payment and Settlement System, which is open to both members and non-members.

Future Reforms

More reforms in the Kenyan financial services sector are under consideration to support the common market protocol, as well as further the status of Nairobi – East Africa’s largest city – as an international financial centre. Owning insurance companies and brokerages has been limited to Kenyan citizens, but according to a report by accounting firm KPMG, those rights may soon be extended to EAC citizens. Insurance brokerages have been opened up to foreigners, and this will allow multinational banks to provide insurance products.

The EAC zone already counts Nairobi as something of a financial centre, and it currently offers a variety of financial products. Banks covering the region tend to house teams there and send them to other EAC markets, and the Nairobi Securities Exchange (NSE) is seeing increased interest in listings from companies in the EAC zone and beyond. Developing Nairobi as a financial hub is a key element of Kenya’s plans for its future, and dovetails with the EAC integration agenda. The National Treasury has proposed amending the Capital Markets Act to enable the issuance of regional securities, including equities, bonds and certificates of deposit.

Looking Further Afield

Exporters will also be able to look to continued trade with European markets. In mid-October 2014 the EU and EAC signed a new economic partnership agreement, which will provide export-oriented companies in the country with major tax relief. Kenya had previously failed to renegotiate its deal with the European bloc, and on October 1, 2014 the EU had put Kenyan goods into a higher tax bracket, following the country’s graduation to lower-middle-income status. This would have made Kenya the only EAC member state facing the new tax burden. Local exporters would have lost as much as KSh100m ($1.14m) per week in taxes paid to access EU markets. In a statement to the press, the Ministry of Foreign Affairs and International Trade said, “The three areas that remained outstanding... were all agreed upon in favour of Kenya.”