Effects of a Common Currency on Intra-regional Trade in Africa: Perspectives on the East African Community Monetary Union

This paper discusses two aspects about a monetary union: first, it presents theoretical arguments and empirical findings suggesting that overall a monetary union itself positively affects intra-union trade which in turn leads to tightly correlated business cycles across countries in the union. Second, using the gravity equation it presents results from both Tobit and OLS models that show the main determinants of bilateral trade among African countries. While common currency does not seem to significantly affect bilateral trade, all traditional gravity model variables including GDP, distance, common border, common language and free trade agreements (FTAs) show the expected sign and high significance. Hence, the paper suggests that these are the main determinants of bilateral trade in African countries and within East African Community (EAC) partner states as well. The paper also shows that pairs of countries joining any FTA, trade about two times as much with each other than they do with countries not in the FTA. Countries using CFA trade more compared to countries that do not use that currency—the effect was between two and four times in 2000 and 2012 respectively, albeit Tobit’s results show unexpected signs. In addition the paper also finds evidence of trade effects within EAC countries. In light of these results, the need for an East African Community Monetary Union can be supported and its on-going process should remain the primary target for partner states.