Lessons from the Euro Debt Crisis:

Part V As was pointed out in two previous articles, EAC does not meet two of the principle criteria for optimum currency area-plus (OCA-P) that is; high degree of economic interdependence (trade integration) and openness; and secondly, there is no single indicator of macroeconomic convergence fundamentals among EAC states at present. And although these may be achieved in the medium term,(assuming measures to do so are put in place) a monetary union would not hold in the absence of the above economic fundamentals. However, another factor critical to the successful implementation of a monetary union, and one that is central to optimum currency area-plus (OCA-P), is fiscal convergence/integration/union.Fiscal criteria focus on the budget deficits as well public debt. The main argument for having rules for fiscal policy is the free-rider problem, that is; some of the costs associated with large budget deficits in one country are borne by the rest member countries. Thus, for instance EMU (European Monetary Union) fiscal rules as enshrined in the Maastricht treaty, 1992, and the growth and stability Pact in 1997, and 2005 limits budget deficit to GDP to 3% and debt to GDP ratio of 60% with fines of up to 0.5% of GDP for excessive deficits. Fines that were never paid even by France and German in early 2000, and a host of other euro countries later on who violated these limits. Perhaps the fundamental flaw in the euro project (and one that EAC will have to put in place to avoid euro crisis replica) is fiscal integration/union without which this project is bound to fail. Monetary convergence and a single supranational central bank are easy to set up, and relinquishing of the country monetary powers to such supranational institution may not face serious political resistance. Surrendering fiscal leverage however, has been the extremely difficult for this is synonymous to surrendering of the country’s economic management, as the country will have no more tools left to stimulate the economy. Few political elite can hardly afford this given that, their electorate have various economic demands/priorities depending upon the stage of development that can hardly converge across board among member states. Monetary union led to high credit rating among EU partner states, and this made countries such as Greece and Portugal vulnerable to a run-up in debt-financed public expenditure (ie this enabled these countries to enter a debt-fueled binge) that may not have been possible in the absence of EU monetary union that far exceeded their capacity to repay back. And although this option is generally unavailable to developing economies such as EAC, since global financial markets would generally not even extend credit to these countries in the first place, nevertheless fiscal integration is even more difficult for the whole structure lacks clear definition as what should be included and at what levels, and they also don’t incorporate fluctuations due to external shocks which in themselves cannot be anticipated in advance. In case of Greece whose public debt-GDP is to-date by far the highest in the world and in excess of 180% of GDP, debt that is too heavy to sustain for the size of Greek economy. Greece did not disclose truly its material economic fundamentals during the entry into the euro, a situation that would have not allowed Greece to join the euro in the first case. Information on economic fundamentals was withheld to enable Greek entry into the euro, but this could not escape the monitoring of European Central Bank (ECB) ie Greece, by the way, is in a class of its own. It never stuck to the 3% target, but manipulated its borrowing statistics to look good, which allowed it to get into the euro in the first place. Its waywardness was uncovered two years ago.However, imposing fiscal policy rules has its own challenges. First, in a monetary unions, member countries can no longer use monetary or exchange rate policies to maneuver their economies nor stimulate growth, and as such they have to rely solely on fiscal tools to do so. Moreover, a part from shame and blame; sanctions are difficult to impose in case of excessive deficits both for political reasons (political elite ignore these) and also because they increase the deficit even more, making it even more difficult to comply with the set rules of prudential deficits. A part from lack of political will to abide by fiscal rules, building of the necessary institutions and the amount of political negotiation as well as technical work thereof, makes fiscal coordination an uphill task for the monetary union. Nonetheless, given low levels of both public and private savings in EA, donor grants and aid will still play a significant role in financing of EAC member states development agenda, so much so that, deficit financing will be inevitable in the medium term. Thus for instance, a number EAC member countries have their budgets financed by donors up to 70% in some cases. Under these conditions, such countries can not claim to be in control of their economic destiny leave alone their currencies whose stability is anchored on availability of donor funding.This is even more pertinent given that, ambitious infrastructure needs of these economies, require long-term funding which cannot be raised from the thin local financial markets, and such donor as well as multilateral financial institutions will have to finance these projects until such a time when these countries build viable financial markets. Unfortunately in EAC, there are no viable strategies among member states to develop financial markets and institutions, except political rhetoric on the same which never serves any purpose to this end. It is often argued that, international financial markets can enforce fiscal discipline by pricing risk associated with increasing sovereign debt. Although this has not been the case even in euro zone, where such markets could be blamed for the indiscipline identified with the current euro debt crisis, and where these same financial markets can not correct the current debt crisis, this cannot be said for EAC. The role of international financial markets in EAC will even be insignificant for their failures in euro zone, is hard lessons to international investors who cannot discount their junk bonds from Greece and other euro zone peripheral countries. Besides, EAC has underdeveloped capital markets that are not integrated with international financial markets, and even then these markets are too thin to efficiently price financial securities and bonds. However, fiscal regimes in EAC are at varying stages of development and the problem of corruption mentioned earlier on makes such fiscal regimes ineligible for a monetary union in the current state, not even in the medium term given the institutionalized corruption in some EAC countries. Furthermore, fiscal convergence among EAC states is bound to be a political wish given that, the criteria set for EAC of 2% is too unrealistic to settle for in a developmental state phase. Across board among EAC member countries, none has ever recorded a deficit below 6% for the last 15 years, and expecting fiscal convergence at 2% is impossible even in the medium term. If fiscal convergence/integration/union is unattainable, the road map to EAC monetary union is, but an end in its self. As pointed out in the previous article, governments with a history of weak monetary discipline, are more often than not likely to have even a more weaker fiscal discipline, and we have a number in EAC mainly a rising of systematic corruption that has been so institutionalized that, it is more of a culture. Under these conditions, limits set by supranational institutions with regard to budget ceilings will be routinely exceeded, so much so that, other member states will pay the price of indiscipline of their other partner states through high interest rates on their bonds/securities sold to raise development financing. For now, monetary economists are in disarray as they have failed to come up with solutions to the current euro debt crisis, one that they cannot escape the blame. The one solution on table, but one that will be difficult to sell to political elite, later on operationalize is fiscal union/ federalism and a common fiscal policy, which might not be acceptable to sovereign states, as this will mean one central budget, and one single budget agency, a situation only feasible for a unitary state. Such a state is utopia in real world.

Insight

Lessons from the Euro Debt Crisis: