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The East African : April 7th 2014
The EastAfrican 42 BUSINESS APRIL 5-11,2014 How moneta≥y ta≥geting f≥amewo≥ks can tame inflation in East Af≥ica in low income economies in Africa, we are in essence discussing the shift from a monetary targeting framework and, in a few cases, a fixed exchange rate framework, to an inflation targeting monetary policy framework. The term “modern monetary W policy framework” is virtually synonymous with “inflation targeting.” Some countries in subSaharan Africa have already adopted an inflation targeting framework; South Africa, Ghana, Mauritius and Uganda. Other countries are implementing hybrid monetary policy frameworks that retain elements of monetary targeting along with elements of inflation targeting, such as setting a publicly announced policy interest rate. But what is the motivation and what are the implications of introducing inflation targeting regimes to low income countries? Over the past two or three decades, monetary targeting frameworks have served subSaharan countries quite well. Monetary targeting brought down inflation in many low income countries, including Uganda in the early 1990s, and maintain it at moderate levels for sustained periods. From the 1990s, macroeconomic management has markedly improved and monetary policy has made a major contribution to this improvement. Since the turn of the millennium, the median of the average annual inflation rates of sub-Saharan low income countries (excluding the fragile states and those that are members of the CFA franc zones) was 8.7 per cent, compared with 17.3 per cent in the 1990s. Many low income countries have annual inflation rates at single digit levels. Paradoxically, it is the achievements brought about by improved macroeconomic management that are High inflation reduces buying power. Many low income economies have single digit annual inflation rates. Picture: File COMMENTARY TUMUSIIME-MUTEBILE “The ability of the central bank to signal its monetary policy stance is crucial for anchoring inflation.” starting to render the monetary targeting frameworks obsolete in many of the low income economies. This is for three reasons. First, monetary targeting frameworks are usually an effective tool for bringing down high rates of inflation, but they are too crude an instrument for controlling inflation that is already at low levels, as is the case in many low income economies. Secondly, the success of macr- oeconomic management in subSaharan Africa over the past two decades has spurred substantial progress in financial deepening and diversification, together with the spread of innovations such as ATMs and mobile banking. In addition, the financial systems of many of the low income economies have become more integrated into global financial markets, with several of these economies now classified as “frontier markets.” Frontier markets are attract- ing portfolio capital, much of which is intermediated through their banking systems. The development and global integration of financial systems in subSaharan countries have weakened the stability of the income velocity of money and that of the money multiplier on which the efficacy of monetary targeting depends. Thirdly, monetary targeting frameworks provide a relatively robust way of managing monetary policy in an environment where an understanding of the processes of inflation is limited, and where accurate data to analyse these processes is lacking. For example, movements in the exchange rate will clearly affect inflation in open economies but play no role in a monetary targeting framework. The improvement in capacities for macroeconomic management, and in the quality and depth of statistical data which have taken place in many low income countries, now affords central banks an opportunity to apply more sophisticated approaches to monetary management that can take better account of the factors underlying inflation and output. When inflation targeting monetary policy frameworks were first adopted in developed economies, and a few of the emerging markets in the 1990s and early 2000s, it was generally thought that they were not suitable for low income economies. The reasons for this skepticism were that low income economies lack deep and well integrated financial markets, which impedes the transmission mechanism of monetary policy, and that the technical capacity for monetary management in these countries was weak. However, the experiences hen we talk about the transition to modern monetary policy frameworks of several developing countries and low income countries that have adopted inflation targeting frameworks over the last decade indicate that this skepticism was unwarranted. Research data from the IMF indicates that the adoption of inflation targeting frameworks has improved macroeconomic management even in countries that lack well developed financial markets and strong technical capacity for forecasting and modelling. It is true that shallow and poorly diversified financial systems impede the transmission mechanism of monetary policy, but financial development is progressing rapidly in low income economies. Vibrant government securities and money markets have developed, and bank intermediation (the share of bank deposits that are lent out to the private sector) has increased. These developments will help strengthen the transmission mechanism of monetary policy. Public expectations In addition, public expecta- tions play a role in the transmission mechanism in economies at all income levels. The ability of the central bank to signal its monetary policy stance is crucial for anchoring inflation expectations. Inflation targeting frame- works place great emphasis on sending a clear message about the stance of monetary policy and on influencing inflationary expectations through careful communication by the central bank with the public and the markets. Weak technical capacity is al- so less of an impediment to the adoption of inflation targeting frameworks than was once believed, not least because technical capacity can be enhanced quickly if the incentives to do this exist. One of the less recognised drawbacks of monetary targeting regimes is that they offer few incentives to technical staff in central banks to develop their analytical capacities beyond examining the details of monetary aggregates. With inflation targeting, staff have to cover the entire spectrum of macroeconomic variables. Tumusiime-Mutebile is the governor of the Bank of Uganda Now ≥einsu≥e≥s can unde≥w≥ite upto $15.2m political, te≥≥o≥ ≥isk By STEVE MBOGO Special Correspondent THE REGION’S reinsurance sector got a boost in the political and terrorism risk segment with the introduction of a new reinsurance product. The product, introduced into the market by Afro-Asian Insurance Services, the regional brokerage representative of Lloyd’s of London, has increased what can be underwritten by more than 220 per cent. The London-based company set up regional offices in Nairobi last year, and was the main reinsurer for Nakumatt’s Westgate Mall branch that was destroyed during an Al Shabaab attack last September. The war in South Sudan and the terrorism threat by Al Shabaab in Somalia, Kenya and Uganda have depressed the flow of foreign direct investments. The maximum insurance regional underwriters could undertake for a single business was Ksh400 million ($4.7 million), but with the new product the risk can be underwritten for up to $15.2 million. “This additional capacity now allows insurance companies to take bigger risks relating to political and terrorism risks, and offers companies and organizations more leeway to increase their investments without the worry $15.2m of such risks,” said Christian Ramamonjiarisoa, the group director for Afro-Asian Insurance in Eastern and Central Africa. “If the capacity exceeds this amount, we can still transfer the reinsurance to London for up to $40 million,” Mr Ramamonjiarisoa added. Regional insurance companies The amount of risk that can be undertaken with the new reinsurance product by Afro-Asian Insurance Services. had been facing capacity challenges to insure large risks. The new product means that local insurers now do not have to seek reinsurance services for high risks abroad. The 2014 Terrorism and Political Violence Map rates 46 per cent of the Eastern Africa region as high or severe in both categories. The report is prepared annually by Aon Risk Solutions. According to the report, terrorism is the predominant risk reinforced by the internationally high profile attack on the Westgate Mall in Nairobi. Kenya risk rating is four (high), the same as Uganda, Ethiopia and Burundi. South Sudan is rated five (severe) similar to the Democratic Republic of Congo and Somalia.
March 31st 2014
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