COURSE PROCEEDINGS:

1.       EVOLUTION OF CENTRAL BANKING IN EAST AFRICA

 ·        The Global Perspective

The oldest Central Bank is believed to have been Bank of Sweden, which was founded in 1668 as a private bank.  Sveriges Riksbank was followed 10 years later by the Bank of England.  The other notable old banks are Bank of Japan and Bundesbank.  However, before Bank of Sweden had been established, several commercial banks had been established but they failed between 1656 and 1663.

Bank failure was not confined to central banks only. The first commercial banking license was given to Johan, who later made the first coins and bank notes but his bank collapsed and he was sentenced to death although there is no evidence of carrying out the threat.

In England, the Bank of England started in 1694 headed by Sir J. Houblon as Governor and was given the right to deal in bullion, issue notes, discount bills of exchange and was able to influence monetary policy.  Most of the bank’s profits came from lending to government although this role was later relinquished to commercial banks.

In Japan, in 1872 the Meiji government had allowed some 150 banks to issue their own notes but this resulted in high inflation, non-convertibility of bank notes, huge government debt and massive bank failures.  This culminated in the formation of Bank of Japan to rescue the situation. Similarly in Germany, the same problems occurred with the Reichsbank; namely heavy financing by government, excessive money printing and galloping inflation.  In 1957, the Bundesbank was established with the objective of controlling monetary policy.

 ·        Central Banking in East Africa

In East Africa, the East African Currency Board (EACB) was established in 1919 with the objective of supplying and controlling currency.  Prior to the establishment of EACB, several currencies were circulating in the region e.g. Indian Rupee.  However, these were later converted into EA shillings.  The EACB managed to achieve continuous convertibility of shillings; with expansion of money supply also tied to growth in foreign assets, there was no inflationary financing.  EACB however failed to expand domestic credit while the board also did not have monetary sovereignty.  Some changes were later made such as allowing limited government borrowing, moving headquarters from London to Nairobi and appointment of board members from member countries.   

Following independence, a recommendation was made to convert EACB into an East African Central Bank with individual independent states establishing smaller country Central Banks.  The new central banks started operations against a background of low growth in money supply, low domestic credit and rapid capital flight as investors became wary of the new situation.  The banks’ policies were towards direct controls e.g., forex controls, preferential rates for agriculture, etc.

The central banks’ were further characterized by excessive government borrowing, accumulated bad debts by commercial banks, excessive government interference and lack of serious supervision of the financial intermediaries. The earlier central banks also wanted to achieve multiple objectives such as development financing, export financing and gave financial guarantees to priority sectors.  These acts led to high levels of inflation with negative real interest rates, and a large parallel market.  After liberalization of East African economies, between 1980-1990, there were deliberate efforts to free the economies from financial repression, state controls and adopt a market economy, which laid the foundation for introduction of indirect instruments for monetary management.

East African Central Banks took measures to maintain positive interest rates, introduced ceilings on government borrowing frequently devalued their currencies and instituted structural measures to eliminate controls then prevalent in the forex market.  The central banks have further pushed for price stability, greater independence and monetary targeting as a means towards stabilization.  These measures have further resulted into adoption of reserve money programming, open market operations and increased competitiveness through licensing of quality banks and restructuring state owned banks. 

 ·        The way forward

Under the East African Cooperation, the central banks are pursuing macroeconomic convergence to achieve a balanced regional flow of resources.  So far, Central Banks have established a Monetary Affairs Committee, there is currency convertibility, joint Banks Supervision and a joint strategy to solve common problems such as bringing down high interest rates.  Other areas of cooperation have included poverty alleviation strategies e.g. seeking for debt relief, formulation of policies for micro finance institutions, etc.  There is also a recommendation for a single currency in the near future, the final goal being an economic and monetary union in the not too distant future.

2.      A CENTRAL BANK WITH EMPHASIS ON CONTEMPORARY

ISSUES AND CHALLENGES

 ·        Introduction:

The paper focused on contemporary Central Banking issues in the East African Region giving particular attention to Monetary Policy Formulation and Implementation to achieve its primary objectives of price stability in view of the challenges arising out of new developments in the global economies and financial markets.

·        Issues: 

Roles and Functions of Central Banks:

-         Traditional

-                     Issue of currency

-                     Banker to Government

-                     Ensuring financial stability

-                     Issue Legal tender

-         Additional

-                     Management of government debt

-                     Overlooking the payment system

-                     Management of external reserves and credit risk registers

-                     Supervise, regulate and control financial institutions

-                     Ensure price stability.

Price Stability: 

-       This was perceived to be the primary objective of Central Banks in the East African Region and therefore, a primary goal of monetary policy. 

-       Price stability in the region was defined as low. A stable domestic inflation has been achieved to single digit levels in the three East African Countries. 

-        The other issues were therefore viewed in relation to the achievement of price stability. 

·        Inflation: 

-        This is measured in Uganda using Uganda Consumer Price Index (CPI) but this is criticized due to high volatility attributed to weather fluctuations. 

-        A viable monetary policy should set an inflation target that is predictable, desirable and acceptably low which in the long run should promote sustainable growth.

·        Monetary Policy:

-        In addition to the above two, monetary policy is also concerned with the following:

-        Stability of foreign exchange markets

-        Interest rates smoothening

-        Financial markets development

-        Liquidity control.

-      These may sometimes conflict and call for trade offs between  price stabilization and other objectives that monetary policy, tend to perceive.

·        New Development in the Financial Markets: 

-        Liberalisation of the Domestic and Foreign Markets.

-        Increased volatility on the exchange rates

-        Currency portifolio changes etc.

These have posed a problem in the formulation and implementation of a viable monetary policy in the region.

·        Challenges: 

As a result of the developments, the central banks have the following challenges: 

-        Defining and managing the supply of money to ensure that Aggregate Demand is consistent with the level of economic activity. 

-        Choosing an appropriate monetary framework that the central banks can use to pursue price stability, the intermediate targets as well as the instruments to use. 

-        Monetary targeting in view of the unpredictable velocity changes and multipliers. 

-        Exchange rate targeting. 

-        Inflation targeting etc.

·        Proposed Courses of Action: 

In view of the developments and challenges above, Central Banks in the region can make the following adjustments to contain the situation, subject to the financial and economic environment. 

-       Take inflation targeting as a monetary framework subject to independence from government fiscal policies, accountability, transparency, commitment etc. 

-       Nurture monetary policy instruments and move from direct to indirect instruments of monetary policy that will compete with the sophisticated financial markets exposed by liberalisation. 

-       Enforce optimal monetary policy rules to avoid dynamic inconsistence i.e fix inflation rates at beginning of period and revise to desired levels in the course of the year. 

-        Endeavour to build credibility, which is a track record for honesty and sends good signals to the market. 

-        Increase supervision and regulation of financial institutions and strengthen the enforcement mechanism.

·        Conclusion: 

It is important that Central Banks achieve full independence in the conduct of monetary policy, free from fiscal authorities if they are to be successful in this noble cause. 

They should also endeavour to maintain financial stability at all costs.

3.      MACROECONOMIC STABILISATION AND REFORM POLICIES:

·         History Of Macro-Economic Stabilization Policies And Reforms:

The 1990s witnessed many Sub-Saharan African (SSA) countries adopting stabilization and structural adjustment programs to correct macro-economic imbalances.  Implementation of these policies has recorded positive results in African countries but these have differed widely due to issues of design, execution, monitoring, aid and policy coordination in the programs.

·         What Necessitated Stabilization And Reform Policies:

In many SSA countries, aggregate demand (AD) had grown relatively faster than aggregate supply (AS).  Aggregate demand was largely accounted for by expansionary monetary and fiscal policies.  Monetary expansion was largely caused by the need for central banks to:

-         Monetize the huge government deficits

-         Support ailing state owned enterprises including perpetually weak financial institutions.

The stabilization and adjustment policies focused on the following:

-         Fiscal and monetary arrangements

-         Liberalization of domestic markets and expansion of the private sector

-         Liberalization of foreign trade and stimulating of exports

-         Financial sector liberalization and reform

-         Rehabilitation of infrastructure – economic, institutional and social.

Some countries have attained success on a sustainable basis while to others it remains an ambition or a short-lived success.

·        Execution, Monitoring And Coordination Of

Stabilization And Reform Policies.

Timing, sequencing, internal consistency and sustainability were important in execution, monitoring and coordination of any reform policies.

Timing has major implications in the size and speed of response of output and investment to these policies.

The aspects of sequencing come from the fact that it has been found undesirable to impose the same approach to all countries because of the varying political, social and economic structures.  It is generally accepted that the liberalization of the domestic financial sector should come after the domestic real sector is liberalized and before the external sector.  Following the same argument, the external sector policies should be sequenced to move from exchange rate control to current account (CA) transactions and then to capital account liberalization.

With internal consistency and sustainability, the country studies suggest that sustainability and consistency of policies are likely to be central in preventing expectations of policy reversals.  Policy inconsistency within the stabilization and reform programs can contribute to weak supply response leading to policy reversals.

Regarding speed and scale, many SSA have followed a big bang approach towards stabilization and liberalization policies.  The “big bang” has the disadvantage of increasing negative effects of uncertainty due to sudden policy change e.g. pre- announcement for the change of policies can have either a positive or negative effect.  For example, Mauritius pre-announcement led to elimination of hoading of foreign exchange and imports, following steps for foreign exchange liberalization.  In Uganda and Mozambique the pre-announcement of the privatization of State owned enterprises led to asset stripping and mismanagement.

·        Leadership And Political Economy:

The success of economic reforms depends largely on political will of the leadership.  This is because it involves all stakeholders.  The winners would support reforms, while the losers frustrate the reform process.

·        Aid And Policy Reform:

A recent World Bank study shows that countries which have successfully reformed, have had clear political movements.  It was noted that aid has influenced policy.  The main finding is that different instruments work in different phases of reform.  Should the donors choose a wrong instrument, at a wrong time, it will either be a waste or counter-productive.  Performance of the different phases of reforms and aid receipts were recorded for three successful low-income reformers – Ghana, Vietnam and Uganda.

In the pre-reform era, poor policy existed just like in our SSA sample.  The beginning of rapid reforms were marked by a new government coming into power.  The shift from rapid reforms to good policy occurs when all the important macro-economic reform have been completed including fiscal reform and trade liberalization.

Second generation reforms follow after the good policy and these require institutional changes and reform in the public sector privatization, civil service reform, judicial reforms, budget reforms to increase the effectiveness of public expenditure and its accountability.  The second generation reforms take more time and require broader participation by all stakeholders in the economy.  It is noted that during this stage most countries have been backsliding in their reform efforts.

The role of aid in the respective stages were as follows:

-         In the poor policy stage, pre-reform, large scale financing and conditionalities all fail in the absence of a serious domestic movement for change.

-         In the era of rapid reforms, aid is used to sustain and consolidate the reform program.

-         In good policy phase, aid is used for supporting policy change, supporting the ownership of the program as opposed to settling conditions e.g. public sector reforms required long-term commitment to institution building, which requires wider participation.

·        Conclusion:

It is generally accepted that stabilization and reform policies are vital for economies that seek macro-economic stability and elimination of structural distortions.  It is very important that each country, when taking on these policies, should consider carefully the issues of execution, monitoring and policy co-ordination.

It is imperative that reform of policies should ensure that the response from the new policies is much better.         

4.      FISCAL POLICY OBJECTIVES AND MANAGEMENT:

·        Objectives:

The objectives of fiscal policy include:

-         Maintaining macroeconomic stability

-         Promoting domestic savings and investment for economic growth

-         Providing public goods and social services

-         Redistributing income

·        Instruments Of Fiscal Policy:

Fiscal policy instruments used to achieve particular social and economic objectives include:

-         Revenue instruments

-                     Taxes e.g. direct and indirect taxes

-                     Non tax revenues e.g. fees, public utilities tariffs and sale of assets.

-         Direct public expenditures e.g. current and capital development expenditures and transfers.

-         Borrowing from domestic sources e.g. banking system and non- bank sources and foreign sources e.g. multilateral institutions, bilateral donor countries and external banks.

·        Fiscal Management:

This encompasses accounting for the use of financial resources and also decisions on the nature of tax policies, government spending and borrowing.

-         Appropriate Tax Policies:

The formulation of appropriate tax policies should conform to the following criteria:

-                     Equity (fair and reasonable)

-                     Economic efficiency (should not impair productive capacity, reduce incentives or distort allocation of resources).

-                     Administrative feasibility (easy to administer)

-                     Revenue elasticity (revenues should increase faster than national income without imposition of new taxes or an increase in tax rates)

-         Diagnostic Tests:

However a good system should pass the following diagnostic tests:

-                     Concentration index – a large share of total tax revenue should come from few taxes and tax rates.

-                     Erosion index – actual tax bases to be as close to potential ones as possible.

-                     Dispersion index – few low yielding nuisance taxes.

-                     Collection lags index – tax payments without much time lag.

-                     Specificity index – tax system should depend on few taxes with specific rates.

-                     Objectivity index – taxes to be levied on objectively levied basis.

-                     Cost of collection index – low fiscal cost of tax collection.

-         Formulation of appropriate expenditure programmes:

Government needs to ensure that resources are best utilized in areas where public sector involvement is considered appropriate e.g. on highly productive investment projects with high rates of return without impairing service delivery.

-         Borrowing: 

When revenues fall short of expenditures, government has to borrow to finance the deficit.  This can be done by borrowing from the Central Bank, the banking system, non-bank borrowing and external borrowing.  This borrowing should be prudent to avoid inflationary implications.

·        Contemporary Issues And Directions For Change:

-         New Approach:

This involves committing entire government apparatus to budgetary stringency and limiting total public spending and imposing cash limits on expenditures, legal limits on budget deficits and public borrowing.  However, crisis budgeting in the sub-Saharan region seems to have eroded the credibility of the budget process.  The budget process in many countries requires enhancement of effectiveness of macroeconomic framework as a basis for allocation and utilisation of resources and re-orientation towards a medium term expenditure framework to accommodate more post-reform fiscal conditions.

·        Conclusion:

Fiscal policy is an important instrument of macroeconomic management which requires to be streamlined especially expenditure management in order to be effective.  Fiscal policy should also be co-ordinated with monetary policy to strengthen price stability.

5.      FISCAL AND MONETARY POLICY CONVERGENCE

AND HARMONIZATION IN EAST AFRICA:

·        Objectives Of The East African Community:

To develop policies aimed at widening and deepening cooperation among East Africa States in political, economic, social and cultural fields, legal and judicial affairs, for their mutual benefit.

-         Areas Of Cooperation:

These include:

-                     Policy oriented programmes e.g. harmonization of monetary and fiscal policies.

-                     Development oriented programmes undertaken by public and private sectors.

·        Harmonisation Of Fiscal And Monetary Policies:

This Means:

-         Adoption of common monetary and fiscal guidelines.

-         Setting common targets e.g. inflation, budget deficits.

-         Coordinating policies towards harmonious development of:

-    Financial Markets

-        Banking laws

-        Banking supervision practices

-        Payment system.

-         Currency convertibility

-         Sharing information on budget formulation and implementation

-         Harmonisation of customs documentation

-         Tariff harmonisation

-         Setting up of institutions or committees to facilitate policy coordination.

·        Pre-Requisites For Harmonization

-         Political will:

-        Consolidation and strengthening existing political will

-        Existence of appropriate institutions, legal and judicial framework

-        Introduction of common rules and regulations.

-         Economic Flexibility

-        Liberalisation of markets

-         Macroeconomic convergence

-        Macroeconomic parameter in the three regions needs to c     onverge to facilitate a balanced regional growth.

·        Targets For Macroeconomic Convergence:

·        Achievement Of Monetary Policy Harmonization:

-         Formation of the Monetary Affairs Committee composed of the three Governors.

-         Currency convertibility facilitating cross border trade.

-         Liberalization of Capital Account  - agreement has been reached towards convertibility of Capital Account in East Africa.

-         Development of Capital markets

-         Joint strategy on Money Markets Development

-         Central Banks are cooperating in various areas.

·        Achievements Of Fiscal Policy Harmonisation:

-         Budget formulation and implementation

-         Customs documentation

-         Permanent Committees have been established under the Umbrella of East Africa Community e.g. Committee on tax harmonization has been formed.

• Challenges And Prospects Ahead:

-         Consolidating and strengthening of existing political will towards integration.

-         Need to develop appropriate institutional, legal and judicial framework.

-         Macroeconomic convergence is in the process of being achieved.

-         Quality improvement of financial infrastructure.

-         Capacity building regarding regional economic policy formulation and analysis.

-         Technological advancement.

-         Capital Account convertibility.

-         Improvement in investment flows.

-         Addressing regional imbalances.

-         Achievement of East African Monetary Union.

6.      CHANGES IN BANKING LEGISLATION IN RESPONSE TO EVOLUTION

OF BANKING SYSTEMS IN EAST AFRICA:  A COMPARATIVE VIEW

·        Introduction:

In the period beginning mid 1980s, the three East African countries were addressing their banking law changes individually.

The re-establishment of the East African Cooperation in the recent past has re-invigorated the need for the harmonisation of the banking laws in the region with a view to achieving convergence in bank regulation, supervision and cross border transaction areas.

In many instances laws are amended or replaced by new ones so that they correspond with new and changing environment within which the business of banking is operated. The new laws are also to vest adequate powers in bank supervisors and regulators over banks and financial institutions.

·        Banking Legislation In Tanzania:

The basic law, which regulates banking business in Tanzania, is the Banking and Financial Institutions Act, 1991. Prior to the enactment of the Banking Act, banking in Tanzania was regulated under the Banking Ordinance, Cap. 430 Legislation, which had been enacted in 1960 by the colonial government. This statute fell out in the advent of the Arusha Declaration in 1967 under the “Ujamaa Policy” but remained in the statutes until it was repealed by the Banking Act in 1991.

·        Banking Legislation In Uganda:

Banking business in Uganda is regulated by the Financial Institutions Statute (FIS) 1993.  This law was enacted in 1993 following the financial sector reform program which begun in 1991 with the support of the World Bank Financial Sector Adjustment Credit.  The enactment of the FIS was meant to lay down a sound legal framework for regulation of banking business in a new environment.  This was meant to correct the legislative deficiencies, which the banking sector experienced under the Banking Act, 1969.  Under the new statute FIS (1993), the Bank of Uganda was conferred with much greater authority over banks and financial institutions whereby it was vested with legal powers to enforce prudent regulation and supervision over them.

·        Banking Legislation In Kenya:

In Kenya, banking business is regulated by the Banking Act, Cap. 488.  This Act was enacted in 1989 and it repealed and replaced the Banking Act, 1969.  Prior to this, banking in Kenya was regulated under the Banking Ordinance.  This was a colonial piece of legislation, which was inherited by the government at independence.  The act gave the Minister for Finance responsibility of licensing banks and non-bank financial institutions and to the Central Bank of Kenya the responsibility of inspecting all financial institutions.  This Act however, had a lot of legislative deficiencies.  The Banking (Amendment) Act, 1985 attempted to rectify these deficiencies. Licensing was henceforth to be routed through the Central Bank of Kenya with the Minister’s approval.  Bank failures also led to the establishment of the Deposit Protection Fund (DPF) in 1986.

·         Comparative View Of The East African Banking Legislation:

-         The changes that took place in the economies of the three East African countries necessitated the banking laws to be re-enacted to be in line with the economic, banking and financial sector reforms which were introduced in these countries during the period beginning early 1980s.

-         The provision on licensing under the Banking Acts of Tanzania and Uganda vest in the central banks powers to issue licences to banks, financial institutions and building societies.  In Kenya, licensing of banks, financial institutions and mortgage finance companies is vested in the Minister.

-         The Tanzanian Banking Act provides for appeals to be made to the Minister where an applicant is aggrieved by the decision of the Central Bank to reject an application for a licence.

-         The Central Banks of Tanzania and Uganda have more autonomy in dealing with license applications than their Kenyan counterparts.

-         The Central Banks in Tanzania and Uganda are the sole authority vested with powers of initiating bank examinations.  Under the Kenya Act, however, both the Central Bank and the Minister may initiate bank examinations.

-         The minimum capital requirements vary in the three d