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.

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%

4. Fiscal Deficit and Financing
14%
12% 1.1%
1.0%
10% 1.5% 1.8%
1.0% 1.2% 1.0% 5.4%
3.2% 5.0%
8%
3.3%
3.3% 3.9% 3.7% 3.6% 4.6%
6%
1.4%
1.2%
4%
6.9% 6.4% 6.4%
5.3% 6.0%
4.4% 4.8% 5.0% 5.1% 4.6%
2% 3.9%
0% -0.4%
-0.9% -0.6%
2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 -1.5%
2007/08 2008/09 2009/10 2010/11p 2011/12b
-2%
-4%
Grants Net Foreign Financing Net Domestic Financing
4

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

11. -10
-5
10
15
20
25
30
35
0
5
1998M01
1998M04
1998M07
1998M10
1999M01
1999M04
1999M07
1999M10
2000M01
2000M04
2000M07
2000M10
2001M01
2001M04
2001M07
2001M10
2002M01
2002M04
Burundi
2002M07
2002M10
2003M01
2003M04
2003M07
Kenya
2003M10
2004M01
2004M04
2004M07
2004M10
2005M01
Rwanda
2005M04
2005M07
2005M10
2006M01
2006M04
2006M07
Tanzania
2006M10
2007M01
2007M04
2007M07
2007M10
2008M01
Uganda
2008M04
2008M07
2008M10
2009M01
2009M04
2009M07
2009M10
2010M01
2010M04
2010M07
2010M10
Annual inflation rates, 1998:1-2011:7
2010M13
2010M16
2010M19

12. 100
150
200
250
50
0
1990
1991
1992
1993
1994
1995
1996
Uganda
Burundi
1997
1998
1999
2000
Kenya
Rwanda
2001
2002
2003
2004
2005
Tanzania
2006
2007
2008
2009
100
150
200
250
50
0
1990
1991
1992
1993
Burundi
1994
1995
1996
1997
1998
Kenya
1999
2000
2001
2002
Rwanda
2003
2004
2005
2006
2007
Uganda
2008
2009
Terms of trade, UNCTAD left, World Bank right

13. 20
40
60
80
0
100
120
140
160
180
200
1998M1
1998M6
1998M11
1999M4
1999M9
2000M2
Burundi
2000M7
2000M12
2001M5
2001M10
2002M3
Kenya
2002M8
2003M1
2003M6
Note: A decline is depreciation. 2005=100.
2003M11
2004M4
2004M9
Rwanda
2005M2
2005M7
2005M12
2006M5
2006M10
2007M3
Tanzania
2007M8
2008M1
2008M6
2008M11
2009M4
Uganda
2009M9
2010M2
Real effective exchange rates (1998:1-2010:12)
2010M7
2010M12

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.

20. 20
40
60
80
0
100
120
140
160
180
200
1998M1
1998M6
1998M11
1999M4
1999M9
2000M2
2000M7
2000M12
2001M5
2001M10
2002M3
2002M8
Note: A decline is depreciation. 2005=100.
2003M1
2003M6
2003M11
Nominal
2004M4
Rwanda (1998:1-2010:12)
2004M9
2005M2
Real 2005M7
2005M12
2006M5
2006M10
2007M3
2007M8
2008M1
2008M6
2008M11
2009M4
Nominal and real effective exchange rates in
2009M9
2010M2
2010M7
2010M12

21. 100
200
300
400
500
600
700
0
1990M01
1990M07
1991M01
1991M07
1992M01
1992M07
1993M01
1993M07
1994M01
1994M07
1995M01
1995M07
1996M01
1996M07
1997M01
1997M07
1998M01
1998M07
1999M01
tea (US cents per kg)
1999M07
COFFEE_ARABIC
2000M01
2000M07
2001M01
2001M07
2002M01
2002M07
2003M01
2003M07
TEA_MOMBASA
2004M01
2004M07
2005M01
2005M07
2006M01
2006M07
2007M01
2007M07
2008M01
2008M07
2009M01
World market price of Arabica coffee and
2009M07
2010M01
2010M07