How Ready is the East African Community for Monetary Union? New Evidence From an Interest Rate Pass-Through Analysis

Abstract

The five member countries of the East African Community (EAC), namely, Burundi, Kenya, Rwanda, Tanzania and Uganda have set the target of achieving a monetary union by 2012. The question that arises is: to what extent are they prepared for a monetary integration? Against this backdrop, this paper evaluates the current level of convergence amongst these East African countries by analysing whether the pass-through of monetary policy in the five countries has become similar over time. We use cointegration, error correction, and asymmetric error correction modelling frameworks and interest rate data over a ten year sample period, from 1999 to 2008, in the analysis. The results suggest that the degree of convergence amongst the countries remains low and that there are significant rigidities in the banking markets over time. While the pass-through of monetary policy has improved with respect to the banking loan markets, it has not done so in the deposit market. Overall the evidence suggests that implementing an EAC-wide monetary union will require more work to be done to stimulate the development of their financial systems and to harmonise their financial and monetary policies.