Exchange Rate Dynamics and Monetary Integration in the EAC Countries

Abstract

A major challenge for most countries in Sub-Saharan Africa is the evaluation of the exchange rate. This is more so in the East African Community (EAC) where macroeconomic and exchange rate management has been particularly challenged by massive foreign aid inflows, which are partly a result of the Heavily Indebted Poor Countries initiative and other debt reliefs. In addition, improved macroeconomic management in the last decade attracted both short- and medium- to long-term inflows to the region, as foreign investors turn to developing and emerging economies for yield. In this paper, we estimate the fundamental equilibrium exchange rate model for all the countries in the EAC and assess the convergence of existing exchange rate regimes in the EAC. Our main contribution is that this exercise could serve as useful background for the ultimate decision of which exchange rate management framework will best fit the region during the transition period to monetary union.