Monetary Unification and Trade Outcome: Evidence from East African Community

Abstract

"This paper examines monetary unification and trade outcome in the case of East African Community (EAC) using the Vector AutoRegressive (VAR) and Augmented Gravity Models for the period 1960-2016. We found that all countries in the EAC have challenges meeting the macroeconomic convergence targets, but Burundi is far from achieving most targets anytime soon. After separating various shocks using VAR, the cross-country correlation estimates show asymmetry of supply and monetary shocks despite external and demand shocks dominating; implying that the region is not an Optimum Currency Area. However, the gravity model shows that monetary unification itself will boost intra-EAC trade to around 60% (a factor of 4) from its current 14%. Thus, between 2006 and 2015, total trade with other EAC countries as percentage of total trade in Burundi averaged 22.5%. It was 30.5% in Rwanda and only 6.1%; 8.4% and 17.4% in Tanzania, Kenya and Uganda respectively. The three countries recorded more exports than imports in EAC leading to an overall intra-regional trade surplus balance while Rwanda and Burundi recorded overall intra trade deficit, as they import more from the EAC than they export. As a result, this study reveals that monetary unification may increase trade among member countries in the EAC since the trade creating effects will offset the business cycle shocks."