regional integration

East Africa Economic Outlook 2019

Macroeconomic developments and prospects

Political economy of

regional integration

East Africa

Economic

Outlook

2019

The opinions expressed and arguments employed herein do not necessarily reflect the official views of the African Development Bank, its Boards of Directors, or the countries they represent. This document, as well as any data and maps included, are without prejudice to the status of or sovereignty over any territory, to the delimitation of international frontiers and boundaries, and to the name of any territory, city, or area.

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© African Development Bank 2019

ISBN 978-9938-882-97-1 (print) ISBN 978-9938-882-97-1 (electronic)

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Acknowledgments v

Executive summary 1

Part 1

Macroeconomic developments and prospects 5

Economic performance and outlook 5

Macroeconomic stability and outlook 8

Domestic resource mobilization 12

Poverty, inequality, unemployment, and structural change 13

Emerging policy issues 17

Part 2

Political economy of regional integration 19

Progress in regional integration 19

Political economy of regional integration 24

Infographic: Moving Across East Africa 28

Intervention strategies and policies to strengthen regional integration 33

Notes 35 References 36 Annexes 39

Statistical annex 45

Boxes

1 The diversity of East Africa 6

2 Progress toward the African Continental Free Trade Area in East Africa 18 3 An empirical analysis of the East African Community’s readiness for monetary union 22 4 The Ethio-Eritrea Peace Agreement and its imperative for regional integration 26

5 Informal cross-border trade in Ethiopia and Uganda 27

Figures

1 GDP growth, by region, 2008–20 6

2 GDP growth in East Africa, by country, 2014–20 7

CONTENTS

3 Overlapping membership in regional economic communities in East Africa 20 4 Revealed comparative advantage of selected African countries and African trading

partners in manufactured goods, 2010–13 32

Tables

1 Inflation in East Africa, by country, 2017–20 9

2 Fiscal balance, including grants, in East Africa, by country 10 3 External current account balance, including grants, in East Africa, by country 11 4 External debt stock and debt indicators in East Africa, by country, 2018 12 5 Domestic resource mobilization and financial sector development in East Africa, by

country, 2016 and 2017 13

6 Poverty and inequality in East Africa, by country, various years 14 7 Structural change, growth, and unemployment, various years 16 8 Macroeconomic convergence criteria in the Common Market for Eastern and Southern

Africa and the East African Community, by country 21

9 Intraregional trade in East Africa, 2012–17 23

10 African Regional Integration Index ranks among Common Market for Eastern and

Southern Africa members, by country, 2016 24

11 Actual intra-Africa trade as a share of potential intra-Africa trade in Common Market for

Eastern and Southern Africa members, by country, 1993–2010 25 12 Exports and imports in East Africa, by country, 2014–17 (exports) and 2017 (imports) 29 A1.1 Real GDP growth rate in East Africa, by country, 2008–20 39 A2.1 External debt accumulation in East Africa, by country, 2008–18 40

A3.1 Unemployment rates in East Africa, by country, 2010–18 40

Statistical tables

1 Basic indicators, 2018 45

2 Real GDP growth, 2010–20 46

3 Demand composition and growth rate, 2017–20 47

4 Public finances, 2017–20 48

5 Monetary indicators 49

6 Balance of payments indicators 50

7 Intraregional trade, 2017 51

8 Demographic indicators, 2018 52

9 Poverty and income distribution indicators 53

10 Access to services 54

11 Health indicators 55

12 Major diseases 56

13 Education indicators 57

14 Labor indicators, 2018 58

The East Africa Economic Outlook 2019 was prepared in the Vice Presidency for Eco- nomic Governance and Knowledge Man- agement, under the supervision and general direction of Célestin Monga, Vice President and Chief Economist, with support from Eric Kehinde Ogunleye, Amah Marie-Aude Ezanin Koffi, Tricia Baidoo, and Vivianus Ngong.

The preparation of the outlook was led and coordinated by Ferdinand Bakoup, Acting Director, Country Economics Depart- ment, with a core team consisting of Abra- ham Mwenda and Marcellin Ndong-Ntah, Lead Economists for East Africa.

The data appearing in the report were compiled by the Statistics Department, led by Charles Lufumpa, Director, and Louis Kouakou, Manager, Economic and Social Statistics Division. Their team included Anouar Chaouch, Mbiya H. Kadisha, Souma- ila Karambiri, Stephane Regis Hauhouot, Sla- heddine Saidi, Kokil Beejaye, Adidi Ivie, and Guy Desire Lakpa.

Contributions were received from Tilahun Temesgen, Chief Regional Economist, and

Patrick Kanyimbo, Principal Regional Inte- gration Officer for East Africa. Alemayehu Geda (University of Ethiopia) contributed a background note to the report. External consultant Esther Katende-Magezi provided the background note for the infographic on people and goods moving across East Africa.

Augustin Fosu (University of Ghana) and Peter Montiel (Williams College) served as peer reviewers.

The cover of the report is based on a gen- eral design by Laetitia Yattien-Amiguet and Justin Kabasele of the Bank’s External Rela- tions and Communications. Editing, transla- tion, and layout support was provided by a team from Communications Development Incorporated, led by Bruce Ross-Larson and including Joe Brinley, Joe Caponio, Meta de Coquereaumont, Mike Crumplar, Peter Redvers-Lee, Christopher Trott, and Elaine Wilson, with design support from Debra Naylor and translation support from Jean- Paul Dailly and a team at JPD Systems.

ACKNOWLEDGMENTS

In 2018, real GDP in East Africa grew by an estimated 5.7 percent, slightly less than the 5.9 percent in 2017 and the highest among African regions. Economic growth is pro- jected to remain strong, at 5.9 percent in 2019 and 6.1 percent in 2020. The countries with the highest economic growth are Ethiopia, Rwanda, Tanzania, Kenya, and Djibouti. In both Ethiopia and Rwanda, real GDP growth has been driven by industry and services. The service sector has also been the main driver of growth in Tanzania and Kenya, followed by the agricultural sector, the main growth driver from the supply side. On the demand side, consumption has been the main driver of eco- nomic growth across East Africa.

The region continues to face various downside risks that could undermine eco- nomic growth and development prospects.

Major risks are agriculture’s vulnerability to the vagaries of nature, heavy reliance on pri- mary commodity exports, and — in oil-import- ing countries — rising oil prices. Another key risk is persistent current account deficits and related increases in external indebtedness.

Finally, state fragility — with its adverse impli- cations for security and economic progress

— is a risk for Burundi, Somalia, South Sudan, and, to some degree, Ethiopia.

Notwithstanding the variation across countries, the region’s fiscal deficit remained low, at an estimated 4.1 percent of GDP in

2018, and is projected to drop to 3.7 percent in 2019 and 3.5 percent in 2020. But cur- rent account deficits remain high, and two patterns are emerging. First, since almost all countries depend on primary commodities for exports, falling global commodity prices have negatively affected their terms of trade.

Second, the region’s high growth has been achieved through high investment, which is above domestic savings. The internal invest- ment–savings gap is strongly associated with the persistent current account deficit (or external gap).

As in 2017, East Africa’s strong growth has not been matched by commensurate and substantial reduction in poverty and inequal- ity. So in 2018, the region is still characterized by high poverty, inequality, and unemploy- ment. Poverty pervades all countries in the region and is extremely high in Burundi and Rwanda and very low in Seychelles, Sudan, and Comoros.

Structural transformation remained mark- edly absent in the region. The service sector dominates the composition of GDP in the region, averaging 59.0 percent, followed by the agricultural sector, averaging 25.7 per- cent. Industry, which includes construction, is very small, averaging 15 percent. Similarly, the average share of manufactured exports

— about 14.6 percent — also indicates the region’s lack of structural transformation.

T

his report analyzes economic growth, its drivers, and its implications for social development (including) poverty, employment, and inequality as well as progress in regional integration in East Africa.

EXECUTIVE SUMMARY

East Africa is showing signs of only partial convergence among key macroeconomic variables used to assess readiness for the EAC monetary union. EAC countries need to strengthen their efforts and further cooperate if they wish to achieve their objective of establishing a monetary union

Countries in East Africa are members of three important regional economic communities (RECs):

the Common Market for Eastern and Southern Africa (COMESA), the Intergovernmental Author- ity on Development (IGAD), and the East African Community (EAC). Progress in regional integra- tion in East Africa varies widely across these three RECs. The EAC is approaching the highest stage, having ratified the protocol for a monetary union, but IGAD is farther behind. COMESA is also work- ing toward a monetary union by 2025, but prog- ress in the prerequisite macroeconomic conver- gence criteria is lagging.

In East Africa, the Continental Free Trade Area (CFTA), launched in Kigali in March 2018, is the latest regional integration initiative. The tripartite free trade area involving COMESA, EAC, and the Southern African Development Community was an important impetus for the CFTA, especially in East and Southern Africa. These initiatives are believed to be advancing regional integration in East Africa.

Notwithstanding the progress in regional inte- gration, intraregional trade in East Africa trade is low, accounting for 8.3 percent of total trade in 2017, less than the continental average of 14.5 percent and roughly unchanged over the past five years. The figure is nearly halved (to 6.9 percent) if Djibouti, with its heavy trade with Ethiopia, and Uganda, with its heavy trade with Sudan and South Sudan, are excluded. Intra-EAC and intra-IGAD trade fares better. Intra-EAC trade is the highest among all RECs in Africa, above 20 percent of exports and significantly higher than the continental average.

East Africa remains susceptible to asymmetric shocks and is showing signs of only partial con- vergence among key macroeconomic variables used to assess readiness for the EAC monetary union. This suggests that EAC countries are not ready for monetary union and need to further align and coordinate their monetary policies. It may be better to fully implement the common market and customs union protocol, further har- monize policies, and increase intraregional trade before adopting a common currency. Adopting a common currency before reaching a greater level of convergence may be damaging.¹

At the country level, Kenya, Uganda, and Sey- chelles had the highest performance in the region

on the African Regional Integration Index, while Eritrea, Ethiopia, Sudan, and Djibouti had the lowest.

There are numerous drivers of — and hence opportunities for — regional integration in East Africa, including considerable unexploited poten- tial in trade, underexploited cross-border transport corridors between landlocked and coastal member countries, endorsement by 44 African countries of the agreement to establish the CFTA, the necessity of regional peace and security that emanates from the large number of fragile states in the region, the recent discovery of natural resources, and substan- tial informal cross-border trade.

Considerable unexploited potential in trade.

Except for Djibouti, which trades heavily with Ethi- opia, intraregional trade is far below its potential

— less than 12 percent for all countries except for Comoros, half the value for Central and West Afri- can countries.

Five landlocked countries. The physical location of the landlocked countries and the existence of the other countries in the region with coastal land mass offer opportunities to enhance regional inte- gration. Similarly, for small island states Comoros and Seychelles, geographic isolation, poor links to the mainland, vulnerability to climate change, and small domestic markets drive regional integration.

Multiple fragile states, particularly in IGAD. Both human-made factors such as conflict and natural factors such as climate change could be causes of fragility and its consequences, including migra- tion and lack of peace and security. On the posi- tive side, the recent peace accord between Eritrea and Ethiopia has already increased cross-border trade and Ethiopia’s use of Eritrean ports, both of which could advance regional integration.

The recent discovery of natural resources and the need to ensure their optimal exploitation.

Natural gas and oil discoveries in Ethiopia, Kenya, Tanzania, and Uganda, existing oil exploitation in South Sudan, Ethiopia’s large hydroelectric power potential and its work toward exporting power to Djibouti and Kenya—and pipeline development for gas and fuel import—and export in Djibouti,

The major challenges of regional integration in East Africa are lack of complementarity in trading, low competitive position of countries to supply goods in the region, institutional capacity weakness to advance regional integration, and failure to address political issues related to regional integration

Ethiopia, and South Sudan are important drivers of and opportunities for further regional integration.

Informal cross-border trade. Estimated to be as high as 50 percent of formal trade in Africa, informal cross-border trade is a diverse source of livelihood for millions of people. High tariff and nontariff bar- riers, excessive regulation, ease of infrastructure in border towns, and distortion in the official market or sectors are usually mentioned as major factors behind informal cross-border trade. So address- ing trade costs, harassment and corruption, infra- structure deficiency, excessive regulation, and excessive requirements at border customs posts and formalizing the informal sector are important policy directions to support informal cross-border trade and enhance regional integration.

Despite these drivers and opportunities, prog- ress in regional integration has been limited. What are the major challenges of regional integration in East Africa? Lack of complementarity in trading, low competitive position of countries to supply goods in the region (which is related to lack of structural transformation, low productivity, and a wide infrastructure gap), institutional capac- ity weakness to advance regional integration, and failure to address political issues related to regional integration.

Several policy directions aimed at boosting regional integration in East Africa emerge from this analysis. First is structural transformation — with its implications for employment and poverty reduction. The terms of trade deterioration and vulnerability of country growth to such external sector shocks is due essentially to trade in primary commodities, which has hindered structural trans- formation. Related to the lack of structural trans- formation is the external sector’s dependence on global commodity prices. When global com- modity prices fall, growth declines and current account deficits and external debt increase. The changing composition of East Africa’s debt toward China (and its export-import bank) and the growth of borrowing from Eurobonds are also making East Africa’s debt not only very burdensome, but also expensive. Sustained and inclusive growth accompanied by substantial job creation, poverty reduction, and healthy external balance is impos- sible without addressing this structural problem.

Second, policymakers need to focus on imple- mentation of regional integration initiatives, which have mostly been incommensurate with signed commitments.

Third is to approach regional integration from multiple dimensions to bring about synergy in trade, infrastructure, productive engagement, and policy and regulatory coordination as well as sociocultural issues.

Fourth, since increased intra-Africa trade is a major policy instrument for advancing regional integration, it is imperative to capitalize on the high political goodwill associated with the CFTA.

The agreement establishing the CFTA also came with an implementation action plan that tackles constraints on intra-Africa trade by holistically addressing trade policy, trade facilitation, produc- tive capacity creation, trade-related infrastructure provision, trade finance, trade information, and factor market integration

Fifth, the lesson from East Asia on the policy direction of structural transformation and process integration is instructive: deliberate and conscious state action — in the form of unilateral tariff reduc- tions, the establishment of export processing zones and duty drawback arrangements, and entry into sectoral trade agreements (especially in infor- mation and communication technology and in the context of value chain creation) — are the foundation for success. East African policymakers may draw an important lesson from this experience and tune their own country policies along this line. These pol- icies also require building the capacity of regional and national institutions tasked with these issues.

East Africa has considerable potential to benefit from regional integration and to advance intra-Af- rica trade to promote sustainable economic growth and development in member countries.

But realizing this potential — and hence the effort to advance regional integration — is challenged by the lack of complementarities of exports and imports as well as the relative competitive position of potential export suppliers. The result of weak infrastructure, productivity, and trade facilitation, this calls for addressing export supply constraints, export competitiveness, and export diversifica- tion, which in turn calls for policies that go beyond liberalization to actual realization of the potential for trade expansion and process integration.

PART 1

MACROECONOMIC DEVELOPMENTS

AND PROSPECTS

GDP growth and its drivers

The countries with the highest economic growth are Ethiopia, Rwanda, Tanza- nia, Kenya, and Djibouti (figure 2; see also table A1.1 in annex 1). In both Ethiopia and Rwanda, real GDP growth has been driven by industry and services. The service sector has also been the main driver of growth in Tanzania and Kenya, followed by the agricul- tural sector, the main growth driver from the supply side.

In countries with low growth, such as South Sudan (–3.8 percent), Burundi (1.4 per- cent), Comoros (2.8 percent), and Somalia (2.9 percent), the main factor is lack of peace and stability, which has disrupted economic activity. In South Sudan, internal conflict dis- rupted oil production, and agricultural pro- duction declined because of poor weather conditions and violent conflict in many areas.

In Burundi, political instability disrupted eco- nomic activity. And in Somalia, the continuing insecurity problem, poor infrastructure, cli- mate change, and low institutional capacity have limited economic growth.

In the rest of East Africa, economic growth rates have been high, ranging from

3.6 percent in Seychelles to 5.3 percent in Uganda. Growth is expected to improve mar- ginally in 2019 in almost all these countries, except Seychelles, where the growth rate is projected to decline by 0.3 percentage point, and Sudan, where the growth rate is projected to decline by 0.5 percentage point.

The main drivers of growth also vary across countries. Despite estimated growth in 2018 being less than the 5.3 percent in 2017, the main drivers of growth in Seychelles remain the traditional tourism and fisheries sectors.

In Sudan, the main driver is the mining sector, despite its small contribution to GDP; the sector is projected to grow by 7 percent in 2019–20. In Eritrea, investment in the mining sector and the government’s agricultural development programs are the primary con- tributors to growth.

Decomposition of GDP growth by sector

In the majority of East African countries, real GDP growth from the supply side is driven primarily by growth in services, followed by industry, where the contribution of the con- struction sector is considerable.

ECONOMIC PERFORMANCE AND OUTLOOK

East Africa comprises 13 countries that are diverse in many aspects (box 1). In 2018, real GDP in the region grew by an estimated 5.7 percent, slightly less than the 5.9 percent in 2017 and the highest among African regions (figure 1). Economic growth is projected to remain strong, at 5.9 percent in 2019 and 6.1 percent in 2020. The regional average masks substantial variation across countries. Estimated GDP growth in 2018 ranged from –3.8 percent (contraction) in South Sudan to 7.2 percent in Rwanda and 7.7 percent in Ethiopia.

Among the fastest growing countries in the region — Ethiopia, Rwanda, and Tanzania, which all saw growth above 6 percent in 2018 — growth on the supply side is driven largely by growth in industry and services. In Ethiopia, industry (especially construction) grew by 18.7 percent in 2016/17, and services grew by 10.3 percent. In Rwanda, industry grew by 8.3 percent, and ser- vices grew by 7.6 percent. Services is also the main driver of growth in Tanzania. The service sector’s contribution to growth was highest in Kenya, at 71 percent, while agriculture accounted for 15 percent and industry for 14 percent.

Among slower growing countries — Djibouti, Eritrea, Seychelles, Sudan, and Uganda, which all saw growth of 3–5 percent in 2018 — growth on the supply side is also driven primarily by growth in services. In Djibouti, services (espe- cially the port facilities, which serve Ethiopia’s increasing cargo) accounted for 77 percent of growth in 2018, followed by industry, which accounted for 19 percent. In Seychelles, services and manufacturing (particularly tourism, trade, and food manufacturing) were also the main driv- ers of growth. And in Sudan, mining and agricul- ture are the leading contributors to growth from the supply side.

In countries with the least growth — South Sudan and Burundi — state fragility in general and conflict and insecurity in particular were the main causes of poor performance. The conflict in South Sudan disrupted oil production, which accounts for more than 70 percent of GDP, and agricultural activities, which account for 10 percent to GDP.

BOX 1 The diversity of East Africa East Africa comprises a diverse set of coun- tries. Populations range from less than 1 mil- lion in Djibouti to more than 100 million in Ethi- opia, the continent’s second most populous country. The structure of the economy varies from South Sudan, where oil accounts for 99 percent of exports, and Somalia, where manufactured exports account for about 1 percent of total merchandise exports, to Kenya, where manufactured goods account for 37 percent of total merchandise exports and the financial sector functions well.

In 2018, eight East African countries had an economic vulnerability index¹ higher than the threshold for classification as a least developed country. Five countries — Burundi, Comoros, Eritrea, Seychelles, and South Sudan — had a value above the aver- age for least developed countries. The most vulnerable countries have different eco- nomic and social characteristics — some are small island states, others landlocked — but generally depend on a few export products and suffer from instability in export earn- ings. And most are extremely vulnerable to natural disasters, with large fluctuations in agricultural production and a high reliance on the agricultural sector.

Note

1. The economic vulnerability index is based on eight indicators that cover exposure to external shocks, distance to the world market, sectoral share of the primary sector, instability of export earnings, and geographic distribution of the pop- ulation, among other things.

Source: UNECA 2019.

FIGURE 1 GDP growth, by region, 2008–20

0 2 4 6 8

(projected)2020 (projected)2019 (estimated)2018 2017

2014–16 2011–13 2008–10 Percent

Central Africa

Southern Africa West Africa

East Africa

North Africa

Africa

Source: African Development Bank statistics.

The prospects of sustained economic growth in the region remain positive, with growth projected at 5.9 percent in 2019 and 6.1 percent in 2020

Major sources and drivers of growth on the demand side

On the demand side, consumption is the main driver of economic growth in East Africa, partic- ularly in the fastest growing economies (Ethiopia, Kenya, Rwanda, and Tanzania). In Ethiopia, pri- vate consumption, was the main driver of growth from the demand side, followed by investment.

In Kenya, private final consumption expenditure accounted for about 84 percent of growth during 2011–18. In Tanzania, private consumption’s con- tribution to growth from the demand side was about 64 percent in 2018, followed by private investment (17 percent), and government con- sumption (12 percent).

Even in countries with the least growth (South Sudan, Burundi, and Comoros), private con- sumption is the driving force behind GDP growth (as well as its contraction) from the demand side.

In South Sudan, real GDP contraction in 2017 was partly the result of a decline in household consumption. Higher public spending due to an increase in salaries in 2017 largely contributed to 56 percent growth in public consumption.

Increased public expenditure is expected to con- tinue driving economic growth on the demand side in 2018.

Opportunities and risks to economic prospects

The prospects of sustained economic growth in the region remain positive, with growth projected at 5.9 percent in 2019 and 6.1 percent in 2020.

In Ethiopia, infrastructure investment, continued expansion in industry and services, sustained agricultural recovery, planned partial privatization, the new prime minister’s democratization reform (which is bringing about political stability), the peace agreement with Eritrea (see box 4 later in the chapter), and the crackdown on corruption will continue to drive high economic growth in 2019 and 2020. In addition, the ongoing program to develop industrial parks, continuing foreign direct investment inflows, and the government’s pro- ductivity-enhancing investments in agriculture are opportunities for continued economic growth.

In Kenya, growth is projected to be 6.0 percent in 2019 and 6.1 percent in 2020, driven by growth in agriculture due to good weather conditions, completion of ongoing infrastructure projects, and continued macroeconomic stability. In Sudan, benefits from the ongoing implementation of mac- roeconomic stabilization and structural reforms, strong rebounds of growth in manufacturing and handcrafts, and the permanent revocation of US FIGURE 2 GDP growth in East Africa, by country, 2014–20

Percent

–15 –10 –5 0 5 10 15

AfricaEast Uganda Tanzania Sudan South Sudan Somalia Seychelles Rwanda Kenya Ethiopia Eritrea Djibouti Comoros Burundi

2020 (projected) 2019 (projected)

2018 (estimated) 2017

2014–16

Source: African Development Bank statistics.

A key risk factor confronting East Africa is persistent current account deficits and related increases in external indebtedness

sanctions (which is expected to normalize Sudan’s relations with creditors and signals positive eco- nomic outlook for the country) are opportunities for increased economic growth.

In Rwanda, the “Made in Rwanda” campaign and policy is expected to narrow the current account deficit, consolidate private sector domes- tic activities, create jobs, and boost economic growth. In Seychelles, vibrant tourism arrival pro- jections and expanding private sector credit are expected to sustain economic growth. And in Eritrea, the normalization of relations with Ethiopia and the related peace and economic cooperation initiative with Djibouti and Somalia bring positive prospects for growth.

East Africa continues to face various downside risks that could undermine economic growth and development prospects. In Ethiopia, the vulnera- bility of rainfed agriculture to vagaries of nature, heavy reliance on agricultural commodity exports, and weak export performance and the resulting foreign exchange crunch are key downside risks.

Political instability also remains a threat in the next two years before the first election after the new prime minister’s political reforms.

In Rwanda, South Sudan, Sudan, Tanzania, and Uganda, which depend heavily on rainfed agriculture and primary commodities for exports, downside risks relate to the climate and global commodity prices. In oil-importing countries, downside risks emanate from rising oil prices.

Kenya’s downside risks also include slow credit uptake by the private sector, lack of fiscal and monetary policy coordination, and failure to raise external resources to finance fiscal deficit. In Sudan, the combined effects of uncertainty due to high inflation and the import rationalization policy are downside risks in the next two years.

Another key risk factor confronting East Africa is persistent current account deficits and related increases in external indebtedness. In Ethiopia, total debt is 60 percent of GDP (divided equally between domestic and external). Much of the external debt is owed to China and has expen- sive terms. A rising fiscal deficit and indebtedness are also risk factors for Kenya and led the gov- ernment to pursue stringent fiscal consolidation measures in 2018. This could be a downside risk for the country if the political will to address the

issue is not forthcoming. Debt stress (especially China debt exposures), with its adverse implica- tions for the current account balance, could also threaten Djibouti, Eritrea, Somalia, South Sudan, Sudan, and Tanzania. Rwanda’s present value of debt–to-export ratio, which stands at 7.2 percent, is expected to increase sharply to 17.3 percent in 2023, when the country’s Eurobonds are due, indicating a downside risk on the horizon. Sey- chelles also faces balance of payment–related risks that need careful management.

Finally, “state fragility” with its adverse impli- cations for security and economic progress, is another risk factor for countries such as Burundi, South Sudan, Somalia, and, to some degree, Ethi- opia. In Somalia and South Sudan, for instance, the security situation, institutional capacity defi- ciency and governance are expected to pose a major downside risk in the coming two years.

MACROECONOMIC STABILITY AND OUTLOOK

A stable macroeconomic environment is one of the major enabling environments for growth and structural transformation.² Because growth and structural transformation are needed to sub- stantially reduce poverty,³ East African countries pay attention to macroeconomic stability. And because macroeconomic instability can lead to political and social instability,⁴ it captures the attention of policymakers and politicians. Inflation, an important indicator of macroeconomic stability, remained in the double digits in 2018, increasing by 0.5 percentage point from 14.0 percent in 2017.

But if South Sudan’s exceptionally high 104.1 per- cent is excluded, the region’s average inflation rate drops to an estimated 12.8 percent in 2018, and is projected to decrease slightly to 10.9 percent in 2019 and 10.2 percent in 2020 (table 1).

Inflation and macroeconomic stability A combination of factors are behind South Sudan’s high inflation rate: rapid currency depreciation, high dependence on imported consumer and capital goods, increased monetization of the high fiscal deficit, GDP contraction due to disruption in oil production, and a general lack of peace and

The region’s overall exchange rate stability and low inflation are generally the result of monetary and fiscal policies that aim for price stability and high growth

security. Inflation also remained high in Burundi and Ethiopia and extremely high (43.4 percent in 2018) in Sudan.

Burundi’s expansionary monetary policy, which began with the 2015 sociopolitical crisis and aimed to facilitate the refinancing of commercial banks in order to support productive investments in 2016 and 2017, continues to place pressure on inflation.

Inflation was estimated at 12.7 percent at the end of 2018 and is projected to sharply increase by 22.1 percent in 2019 and 23.1 percent 2020.

In Ethiopia, inflation pressure came from sig- nificant public spending, the 15 percent currency devaluation, shortage of foreign currency, and limited food supply. In Sudan, inflation increased by more than 10 percentage points from 2017 to 2018 and is projected to remain high, at 35.0 per- cent in 2019 and 33.1 percent in 2020, driven mainly by the weakening of the currency and mon- etization of the deficit.

Rising inflation is generally associated with cur- rency depreciation and exchange rate instability.

So another important aspect of macroeconomic stability in East Africa relates to exchange rate con- ditions. The region’s overall exchange rate stability

and low inflation are generally the result of mone- tary and fiscal policies that aim for price stability (including the exchange rate) and high growth. In Kenya, the central bank continued to pursue that stance to ensure price and exchange rate stability and stimulate growth when needed. The central bank loosened its monetary policy stance recently by reducing the interest rate to 9.5 percent in March 2018 and to 9 percent in July 2018 to stimu- late the economy. It also introduced various mone- tary policy instruments to manage system liquidity, including foreign exchange sales to reduce pres- sure on the shilling and minimize exchange rate passthrough to inflation. Thus, despite the interest rate decline in 2018, inflation remained low, and the shilling’s exchange rate with major currencies remained stable. A similar macroeconomic policy stance has resulted in a stable exchange rate in Ethiopia, Rwanda, Seychelles, and Tanzania.

The situation differs in postconflict (Eritrea) and conflict-ridden and unstable (Somalia, South Sudan, and Sudan) countries. In Eritrea, the offi- cial exchange rate of the nakfa remains fixed at 15.075 per US dollar, but on the parallel market, the exchange rate fluctuated between 20 and 24 TABLE 1 Inflation in East Africa, by country, 2017–20 (%)

2017 2018

(estimated) 2019

(projected) 2020 (projected)

Burundi 16.1 12.7 22.1 23.1

Comoros 1.0 2.0 2.0 2.0

Djibouti 0.6 0.8 2.4 2.7

Eritrea 9.0 9.0 9.0 9.0

Ethiopia 7.2 13.0 9.3 8.5

Kenya 8.0 4.8 5.5 5.4

Rwanda 8.2 0.9 4.1 4.0

Seychelles 2.9 4.4 3.6 3.1

Somalia 2.9 5.1 4.7 4.6

South Sudan 187.9 104.1 108.2 91.4

Sudan 32.6 43.4 35.0 33.1

Tanzania 5.3 4.8 5.2 5.1

Uganda 5.6 3.2 4.3 4.8

East Africa 14.0 14.5 12.5 11.4

Excluding South Sudan 11.3 12.8 10.9 10.2

Source: African Development Bank statistics.

The region’s fiscal deficit remained low, at an estimated 4.1 percent of GDP in 2018, comparable to the average for all of Africa

nakfa per US dollar.⁵ In Somalia, the shilling has stabilized at 23,606 per US dollar since the end of 2017, but counterfeit currency remains a major challenge for the central bank in the financial sector in general and the exchange rate market in particular. In South Sudan, the 30 percent increase in the monetary base in 2018, driven by monetization of the fiscal deficit, and the high infla- tion that followed, led to a substantial depreciation of the South Sudanese pound, from 117 per US dollar in June 2017 to 140 in June 2018 in the offi- cial market and to 316 in May 2018 in the parallel market. In Sudan, the Sudanese pound contin- ued to weaken in 2018, and the country’s multiple exchange rates have yet to be unified.

Fiscal and current account balances The region’s fiscal deficit remained low, at an esti- mated 4.1 percent of GDP in 2018 (table 2), com- parable to the average for all of Africa. Although the deficit was up in 2018 from 2017, it is pro- jected to drop to 3.7 percent of GDP in 2019 and 3.5 percent in 2020. The aggregate figure hides some high country values — Burundi, Djibouti, and Eritrea each have a fiscal deficit more than twice

the regional average. But in 9 of the region’s 13 countries, the fiscal deficit is below 5 percent of GDP, thanks to modest increases in public spend- ing and better revenue generation. This general picture is projected to prevail in 2019 and 2020.

The high fiscal deficits in Burundi, Djibouti and Eritrea in 2018 are the result of several factors.

Weak economic activity, weak tax collection, and a less attractive business environment.

The region’s current account deficit was an estimated 4.9 percent of GDP in 2018, largely unchanged from 2017, and is projected to improve slightly in 2019 and 2020 (table 3). The current account balance ranges from a deficit of 18.2 per- cent of GDP in Seychelles and 17.8 percent in Djibouti to a deficit of 2.4 percent in Sudan and a surplus of 0.3 percent in Eritrea.

The highest current account deficits — more than twice the region’s average and thus in the double digits — are in Burundi, Djibouti, Seychelles, and South Sudan. The main factors behind the high deficit varies across these countries. Lower exports growth than imports growth for food and capital goods in Djibouti. External shocks, includ- ing rising fuel prices, a decline in the number

TABLE 2 Fiscal balance, including grants, in East Africa, by country (% of GDP)

2017 2018

(estimated) 2019

(projected) 2020 (projected)

Burundi –6.5 –8.8 –8.8 –10.3

Comoros 0.4 –3.1 –5.4 –5.8

Djibouti –15.3 –15.5 –16.0 –15.4

Eritrea –13.8 –12.6 –12.4 –14.4

Ethiopia –3.3 –3.0 –2.9 –2.9

Kenya –8.9 –6.7 –5.7 –4.9

Rwanda –4.8 –4.3 –4.4 –3.6

Seychelles 0.0 –0.3 –0.4 –0.1

Somalia ... ... 0.1 0.1

South Sudan 5.8 –1.5 –1.4 –2.8

Sudan –1.9 –2.2 –1.6 –1.2

Tanzania –1.2 –3.9 –3.3 –3.5

Uganda –3.9 –4.7 –4.4 –4.3

East Africa –3.8 –4.1 –3.7 –3.5

... is not available.

Source: African Development Bank statistics.

Since almost all countries depend on primary commodities for exports, falling global commodity prices have negatively affected their terms of trade, resulting in the persistent current account deficits

of tourists, and stagnation in its exports in Sey- chelles. The disruption in oil production and trade (the result of political instability) in South Sudan.

Five countries have a current account deficit of 5–10 percent: Comoros, Ethiopia, Kenya, Rwanda, and Somalia. In these countries, the deficit is gen- erally the result of excess imports over exports, which is strongly associated with the internal deficit (investment being much larger than domestic sav- ings), particularly in Ethiopia and Somalia. In Ethi- opia, this is aggravated by a decline in commodity prices and shortfalls in the services account. The pattern is similar in Kenya and Somalia.

Two patterns have emerged in the region’s continued current account deficits. First, since almost all countries depend on primary commod- ities for exports, falling global commodity prices have negatively affected their terms of trade, resulting in the persistent current account deficits.

The terms of trade for Africa as a whole deterio- rated from 193 in 2012 to 157.1 in 2016 and 168.7 in 2017, primarily because of falling primary com- modity prices.

Second, the drive for rapid economic growth and the resulting high growth have been achieved

through high investment, which is above domes- tic savings. The internal investment–savings gap, where investment is characterized by significant import content as well as a demand for imports that is generally inelastic, is strongly associated with the persistent current account deficit (or external gap). The resulting current account deficit is invariably financed by a combination of external finance, which leads to indebtedness, and mone- tization, which leads to inflationary pressure. The rising external debt in the region (see table A2.1 in annex 2) is in turn leading to further increases in the current account deficit through debt ser- vicing costs. In 2018, debt service in Ethiopia was $1.2 billion, or nearly a third of total exports ($3 billion), aggravating the current account deficit and forcing the country to reschedule its debt.

In absolute terms, debt stock is largest in Sudan (55.4 billion), Kenya (42.7 billion), and Ethiopia ($25.6 billion; table 4). Debt stock as a share of GDP is above 30 percent in all East Afri- can countries except in Burundi, Comoros, and Eritrea and is highest in Sudan (166.6 percent).

The region’s debt comprises bilateral, multilateral, and private flows. On average, 65.6 percent of TABLE 3 External current account balance, including grants, in East Africa, by country (% of GDP)

2017 2018

(estimated) 2019

(projected) 2020 (projected)

Burundi –11.6 –10.4 –9.2 –11.2

Comoros –4.3 –6.0 –7.7 –7.4

Djibouti –17.5 –17.8 –16.3 –16.9

Eritrea 0.7 0.3 –1.1 –2.1

Ethiopia –8.1 –6.0 –5.9 –5.8

Kenya –6.7 –5.8 –5.2 –5.3

Rwanda –6.8 –8.4 –9.2 –8.3

Seychelles –20.5 –18.2 –17.6 –17.0

Somalia –6.7 –7.2 –6.5 –6.3

South Sudan 1.7 –12.7 –10.1 –0.3

Sudan –2.5 –2.4 –2.2 –1.9

Tanzania –3.3 –3.7 –3.4 –3.3

Uganda –4.3 –4.9 –4.9 –5.4

East Africa –5.0 –4.9 –4.6 –4.6

Source: African Development Bank statistics.

Domestic resource mobilization is a major challenge in East Africa

external debt is obtained on concessional terms and in foreign currency, with 58.6 percent in US dollars in 2016. The risk of debt stress is low in Kenya, Rwanda, Tanzania, and Uganda and high in the region’s remaining countries.⁶ Based on the World Bank’s Country Policy and Institutional Assessments, the debt policy indicator index is 1.5–2.5 on a scale of 1 (worst performance) to 6 (best performance) for Burundi, Comoros, Dji- bouti, and Sudan and 4.5 for Kenya, Tanzania, and Uganda.⁷

The debt-to-exports ratio is above 100 percent for all East African countries except Seychelles.

And in Burundi, Ethiopia, and Kenya, debt service is putting tremendous pressure on limited foreign exchange earnings (see table 4). Many of these countries have already benefited from the Heav- ily Indebted Poor Country Debt Relief Initiative and the Multilateral Debt Relief Initiatives. Since 2010, African indebtedness has doubled, and in some cases tripled.⁸ And debt is increasingly dominated by bilateral flows coming from Brazil, India, Russia, South Africa, and particularly China.

Credit form China is increasingly important in the region because of the Chinese government’s policy of “going global” and because of its easy

access to African countries. But its credit terms are expensive, especially compared with those of multilateral loans.⁹ This is an emerging policy con- cern for African countries in general and to coun- tries in East Africa in particular.

DOMESTIC RESOURCE MOBILIZATION

Domestic resource mobilization is a major chal- lenge in East Africa.¹⁰ Countries with tax revenues below 15 percent of GDP have difficulty funding basic state functions. From 1998 to 2008, tax-to- GDP ratios in the EAC ranged from 12 percent to 22 percent, compared with 36 percent in Organ- isation for Economic Co-operation and Develop- ment countries and 25.4 percent in South Africa (table 5). Tax revenue in fragile states is generally below 15 percent.¹¹ East Africa has multiple frag- ile states, so domestic resource mobilization is far below what is needed to spur investment and growth. The low domestic saving and high nec- essary investment are leading to persistent fiscal deficits and growing indebtedness. In Ethiopia, investment as share of GDP was about 40 percent TABLE 4 External debt stock and debt indicators in East Africa, by country, 2018

Total debt stock ($ billions)

Debt-to-GDP ratio

(%)

Debt-to-exports ratio

(%)

Debt service–

to-exports ratio (%)

Burundi 0.5 14.9 294.7 21.1

Comoros 0.2 26.5 146.4 8.8

Djibouti 2.2 102.9 374.8 19.2

Eritrea 1.3 20.1 201.8 6.8

Ethiopia 25.6 30.5 385.4 29.7

Kenya 42.7 47.6 352.7 70.7

Rwanda 4.0 41.4 176.1 5.4

Seychelles 1.6 99.6 93.5 4.5

Sudan 55.4 166.6 1,133.9 4.4

Tanzania 19.2 34.6 187.2 12.8

Uganda 12.5 45.0 239.9 17.1

East Africa 165.2 52.5 370.3 27.4

Note: Data for Somalia and South Sudan are not available.

Source: African Development Bank statistics and International Monetary Fund World Economic Outlook database.

It is imperative to implement policies that enhance domestic resource mobilization, including improved tax administration, financial sector development, and financial innovation

in 2017, while domestic saving as share of GDP was about 22 percent (though experts estimate that it is closer to 10–15 percent). This wide gap is financed through debt, leading to a debt-to- GDP ratio of close to 60 percent, divided equally between external and domestic.

It is imperative to implement policies that enhance domestic resource mobilization, includ- ing improved tax administration, financial sector development, and financial innovation. In addi- tion, illicit financial flows from Africa could be as much as $50 billion a year, more than double official development assistance.¹² Over 1970–

2010, African lost an estimated $1.3 trillion in the form of capital flight, many times the continent’s

debt stock of $283 billion.¹³ Thus, policies that curb capital flight and possibly reverse what is already left could contribute to domestic resource mobilization.

POVERTY, INEQUALITY, UNEMPLOYMENT, AND STRUCTURAL CHANGE

As in 2017, East Africa’s strong growth has not been matched by commensurate and significant reduction in poverty and inequality.¹⁴ As a result, in 2018 the region remains characterized by high poverty, inequality, and unemployment.

TABLE 5 Domestic resource mobilization and financial sector development in East Africa, by country, 2016 and 2017

Country Year M2

(% of GDP)

Domestic credit in banking sector (% of GDP)

Domestic credit to the private

sector (% of GDP)

Gross domestic saving (%

of GDP)

(%) Tax-to-GDP ratio

Burundi 2016 23.7 35.0 16.7 –8.8 ...

2017 24.7 32.8 13.8 ... ...

Comoros 2016 45.7 31.3 26.5 ... ...

2017 45.1 30.2 27.3 ... ...

Djibouti 2016 96.9 34.6 30.2 11.6 ...

2017 113.0 35.0 31.7 10.3 ...

Ethiopia 2016 4.0 ... 22.4 ... ...

2017 3.5 ... 24.1 ... ...

Kenya 2016 38.4 42.6 32.7 7.6 15.8

2017 38.9 42.6 31.0 5.4 ...

Rwanda 2016 20.8 18.9 21.0 7.7 14.8

2017 ... 19.0 20.9 8.9 ...

South Sudan 2016 31.7 1.0 13.4 2.0 10.5

2017 ... 1.0 ... ... ...

Sudan 2016 20.3 22.5 8.9 20.0 ...

2017 ... ... ... 20.9 ...

Tanzania 2016 22.2 20.2 14.4 23.9 ...

2017 ... ... ... ... ...

Uganda 2016 22.9 23.4 15.6 15.5 13.5

2017 23.4 23.2 15.0 16.5 ...

... is not available.

Note: Data for Eritrea, Seychelles, and Somalia are not available.

Source: World Bank 2018b.

Trends in poverty and inequality

Poverty pervades all East African countries, though the region’s average (33.3 percent at $1.90 a day and 55.3 percent at $3.10 a day) is lower than the Sub- Saharan Africa average (42.1 percent and 66.3 percent; table 6). Poverty is lowest in Sey- chelles, Sudan, and Comoros and highest, above 60 percent at $1.90 a day, in Burundi and Rwanda.

Poverty is more pronounced at $3.10 a day, rang- ing from about 40 percent in Comoros and Sudan to an extremely challenging 89 percent in Burundi.

The situation is also reflected in the United Nations Development Programme’s Human Development Index values, which range from 0.400 (on a scale of 0, low, to 1, high) in Burundi and 0.420 in Eritrea to 0.550 in Kenya, with Seychelles (0.780) an outlier.¹⁵

East Africa faces a severe inequality prob- lem. On average, 48.4 percent of income goes to the richest 20 percent of income earners in the region, and 30 percent goes to the richest 10 per- cent. By contrast, only 6 percent of income goes to the poorest 20 percent, and only 2.3 percent goes to the poorest 10 percent. But averages

hide considerable variation across countries.

Inequality is highest in South Sudan, Comoros, and Djibouti and lower in Burundi, Tanzania, and Sudan. Inequality should be a major concern for policymakers because it adversely affects poverty reduction and causes a lack of social cohesion that could lead to conflict.¹⁶

It is striking that poverty and inequality are so high despite efforts to address them. In Ethio- pia, the government committed 60 percent of its 2018 budget to poverty-targeted sectors such as education, health, agriculture, water, and roads.

Tanzania and Sudan had a similar focus on rais- ing agricultural productivity and pursuing growth led by agro-industrialization. The persistent pov- erty and inequality call for further research and re-examination of the policies pursued. In coun- tries such as Somalia and South Sudan that have faced peace and security challenges and need policy direction most, spending has focused on defense and security, the priorities for these coun- tries, rather than on agriculture and related pover- ty-reducing sectors.

TABLE 6 Poverty and inequality in East Africa, by country, various years

Poverty Inequality

Reference year

Population living on less than 2011 PPP

$1.90 a day (%)

Population living on less than 2011 PPP

$3.10 a day

(%) Reference

year

Share of income going to each population segment

(%) Richest

10% Richest

20% Poorest

10% Poorest 20%

Burundi 2006 71.7 89.2 2013 31.0 46.3 2.8 6.9

Comoros 2013 18.1 38.1 2014 33.7 50.4 1.6 4.5

Djibouti 2013 22.5 44.6 2013 34.1 50.0 1.7 4.9

Ethiopia 2010 33.6 71.3 2015 31.4 46.7 2.6 6.6

Kenya 2005 33.6 58.9 2015 31.6 47.5 2.4 6.2

Rwanda 2013 60.4 80.6 2012 37.9 52.2 2.4 6.0

Seychelles 2014 1.1 2.5 2013 39.9 53.0 1.9 5.4

South Sudan 2009 42.7 63.5 2010 33.2 50.6 1.3 3.9

Sudan 2009 14.9 38.9 2009 26.7 42.4 2.6 6.8

Tanzania ... ... 2011 31.0 45.8 3.1 7.4

Uganda 2012 34.6 65.0 2016 34.2 49.8 2.5 6.1

Average 33.3 55.3 30.0 48.4 2.3 6.0

... is not available.

Note: Data for Eritrea and Somalia are not available.

Source: World Bank 2017.

East Africa’s economic structure and growth patterns are characterized by low industrialization

— including lack of economic diversification, product

differentiation, and sophistication — and insufficient job creation

Unemployment, structural change, and poverty reduction

The impressive growth of East Asian economies such as China, the Republic of Korea, and Taiwan over the past four decades shows that high and inclusive growth underpinned by structural trans- formation can greatly reduce poverty. The limited change in poverty in Africa, despite impressive nontransformational and noninclusive economic growth since the turn of the century, supports this conclusion.¹⁷

This report advocates for structural transfor- mation policies in line with much research over the past few years. Africa’s impressive growth between 2000 and 2009 was the result of rapid growth in exports of hard commodities and cap- ital inflows. Most of the extra income generated was absorbed by middle-class consumption.¹⁸ In 38 of 49 countries, imports grew more than exports after this growth episode. Only agricul- ture grew slowly, and most countries experienced deindustrialization. This growth pattern did not create enough decent jobs for young people. It also established a vulnerable economic structure in which the entire economy depends on a single or small number of commodity exports.¹⁹ The pat- tern results from low industrialization and value adding economic activity.²⁰ Thus, inclusive and transformative development strategies are essen- tial for translating Africa’s recent growth momen- tum into decent jobs and poverty reduction.

Industrialization is often taken as a sure way of breaking the commodity boom and bust cycle and ending dependence on primary commodity exports.²¹ In Africa, the process entails a relative decline in low-productivity agriculture and low value added extractive activities and a relative increase in manufacturing and high-productivity services.²² African economies’ inability to accel- erate this diversification and structural transfor- mation, and hence to benefit from the technol- ogy-driven dynamism of globalization, has kept them vulnerable to external shocks and resulted in limited poverty reduction. This is why structural transformation is advocated as policy direction for job creation and poverty reduction in a sustainable manner.²³

This policy direction is also motivated by the contrasting poverty reduction outcome of growth

with structural transformation in East Asia and without structural transformation in Africa. Despite Sub- Saharan Africa’s impressive growth since 2002, 47 percent of the population still lives on less than $1.25 a day. Between 1981 and 2008, the poverty rate declined by only 4 percent- age points. In contrast, East Asia’s poverty rate dropped dramatically, from 77 percent in 1981 to 14 percent in 2008, or 63 percentage points.²⁴

Changing the sectoral composition of growth was also important in reducing poverty in Asia.

But to promote growth of the appropriate sector, policymakers must carefully study the country sit- uation. Where poverty is high in the rural sector and structural transformation possibilities are low, agricultural growth remains important for some time. Otherwise, growth in the secondary sector may be more inclusive. Both approaches require active policies to abate inequality and ensure a flexible labor market with high labor absorp- tion.²⁵ India has also seen structural transforma- tion reduce poverty, but the country’s experience shows that structural transformation needs to be accompanied by distributional policies and that increasing the share of industry is reduces poverty while increasing the share of services and agricul- ture is poverty neutral.²⁶

Services dominate the composition of GDP in East Africa, at 59.0 percent in 2016, followed by agriculture, at 25.7 percent (table 7). Industry, which includes construction, accounts for only 15.3 percent of GDP, below the Sub- Saharan Africa average of 27.7 percent. East Africa’s eco- nomic structure and growth patterns are charac- terized by low industrialization — including lack of economic diversification, product differentiation, and sophistication — and insufficient job creation.

Similarly, manufacturing value added grew by just 1.7 percent over 2000–16, which was less than GDP growth, reducing the manufacturing sector’s share in GDP. Average manufacturing value added in GDP was just 8.1 percent, far below the Sub- Saharan Africa average of 10.3 percent in 2016.²⁷ The average share of manufactured exports in total merchandise trade, 14.6 percent, also shows the region’s lack of structural transformation. Notwith- standing this poor performance on average, some countries — Ethiopia, Kenya, Tanzania, and Uganda

— have made progress in industrialization recently.

One implication of the lack of structural trans- formation in East Africa is high unemployment, despite strong growth. Unemployment averages 36.9 percent and ranges from 15.0 percent in Rwanda to 59.4 percent in Comoros (see table 7).

Youth unemployment, at 48.2 percent, is a major problem. African economies’ failure to transform structurally from low-productivity agriculture to higher productivity nonagricultural sectors com- bined with high fertility and low infant mortality has limited change in the structure of employment.

The lack of formal wage jobs is forcing young people to search for innovative employment in agriculture and informal household businesses.²⁸ Because the informal economy will remain import- ant for employing young people, policymakers must raise its productivity, support it, and eventu- ally formalize it.²⁹ Policies will vary from country to country. But Ethiopia shows that providing credit using micro finance institutions, providing working space, relaxing some regulations, and offering tax incentives can provide the necessary support.

The slow progress in reducing unemployment (see table A3.1 in annex 3) has implications for poverty and inequality, and governments in East Africa are taking policy initiatives and actions to address the challenge. Ethiopia is tackling lack of structural transformation with its five-year Growth and Structural Transformation Plan II. In Kenya, the government created a Vision 2030 policy framework to address the slow progress in pov- erty reduction due to lack of structural change.

And in Rwanda the National Strategy for Trans- formation launched in 2017 aims to bring about structural transformation through the “Made in Rwanda” campaign.

Poverty in Africa is still spatial — and highly prev- alent in rural areas. Inclusive growth has encoun- tered specific sectoral challenges — including poor rural infrastructure, failure to modernize rural livelihoods, and little job diversification.³⁰ This underscores the importance of looking at the spatial dimensions of structural transformation, particularly in East Africa, and pursuing spatial TABLE 7 Structural change, growth, and unemployment, various years

Manufactured exports (% of total merchandise

trade)

Sectoral share of GDP, 2016

(%) Unemployment, 2017

Agriculture Industry Services

International Labour Organization model-

based estimate (% of population)

Total (% ages 15

and older)

Youth (% ages

15–24)

Burundi 12.8 (2017) 36.5 15.1 48.4 1.6 22.4 49.0

Comoros 21.7 (2013) 33.6 10.8 55.7 4.3 58.8 87.9

Djibouti ... 2.2 15.5 82.3 5.8 44.4 66.5

Ethiopia 12.5 (2015) 34.1 22.9 43.0 6.4 21.8 36.0

Kenya 36.8 (2013) 31.5 17.5 51.0 5.2 42.1 30.5

Rwanda 12.2 (2016) 31.0 15.8 53.3 11.5 15.0 74.8

Seychelles 8.2 (2016) 2.0 11.4 86.7 3.7 35.6 25.9^a

Somalia 1.3 (2009) ... ... ... 6.0 56.6 50.8

Sudan 0.5 (2012) ... ... ... 11.5 59.4 80.3

Tanzania 25.0 (2016) 30.5 26.4 67.3 12.7 18.5 50.1

Uganda 25.0 (2016) 30.1 20.0 43.5 2.2 30.8 30.6

Average 14.6 25.7 15.3 59.0 6.4 36.9 48.2

... is not available.

a. Based on national estimates.

Note: Data for Eritrea and South Sudan are not available.

Source: Based on World Bank 2018b.

Structural transformation — with its implications for employment and poverty reduction

— is the main policy issue emerging in East Africa

targeting — strategically directing and prioritizing investments and interventions to leverage the advantages of spatial areas such as urban cen- ters for industrial development. In short, when a policy for structural transformation is envisaged, it is imperative to recognize the spatial dimen- sions of what to produce and where to produce it. Strategies should be tailored to the specific spatial needs of targeted sectors and firms, which may have a regional dimension.³¹ Policies target- ing spatial investments should thus consider both national and regional economic geography.

EMERGING POLICY ISSUES

Structural transformation — with its implications for employment and poverty reduction — is the main policy issue emerging in East Africa. This is because structural transformation is related to terms of trade deterioration, vulnerability of coun- tries to external shocks and indebtedness, and low-quality growth — growth that is vulnerable to global primary commodity prices, that is not accompanied by structural transformation, and that has limited effect on employment and poverty.

All East African countries export mainly pri- mary commodities and import manufactured goods. The terms of trade of primary commodi- ties with respect to manufactured goods in Africa was deteriorating for more than a century before improving between 2003 and 2013, when global commodity prices started to improve.³² The terms of trade challenge is attributed largely to Africa’s primary commodity dependence, based in histor- ical reasons.³³ That dependence has re-appeared in the recent economic engagement with China, India, and other emerging economies. The terms of trade deterioration and vulnerability of African

countries’ growth to such external sector shocks has resulted in an economic structure that has hindered structural transformation.³⁴ Thus, sus- tained and inclusive growth that is accompanied by significant job creation and poverty reduction is impossible without addressing Africa’s fundamen- tal structural problems through appropriate strat- egies.³⁵ This is an emerging and vital policy issue in East Africa too.

A related emerging policy issue is persistent current account deficits and growing external indebtedness, which are related partly to declining global commodity prices. The changing compo- sition of East Africa’s debt toward China and its export-import bank as well as the growth of bor- rowing from Eurobonds are making East Africa’s debt not only very burdensome, but also more expensive as global financial conditions tighten.

The debt burden requires proper debt manage- ment in the short run and structural transformation to reduce commodity dependence in the medium to long run.

Low-quality growth is also another emerging policy issue. It is imperative to diagnose the nature of the region’s growth in order to identify the right strategies, policies, and programs to improve its quality — that is, to ensure that it is accompanied by structural transformation that is inclusive and reduces poverty.

The finally emerging policy issue is regional integration. The prospects for regional integra- tion have looked bright for the past few years, as suggested by the signing of the agreement estab- lishing the CFTA by almost all East African coun- tries as well as by IGAD member countries’ active involvement in peace and security (box 2). But regional integration is challenged by implementa- tion incommensurate with signed commitments.

This topic is addressed in more detail in part 2.

BOX 2 Progress toward the African Continental Free Trade Area in East Africa

The signing of the agreement establishing the African Continental Free Trade Area (CFTA) in March 2018 in Kigali by 44 countries represented a milestone toward a unified African market. The CFTA’s elimination of tariffs and nontariff barriers offers East Africa improved development prospects. But only half the 22 ratifications needed by March 2019 for the CFTA to go into force have been made so far. The delay in implementation will hold back the CFTA’s expected complimentary benefits of promoting regional integration in East Africa.

Establishing a continental market compliments regional integration efforts. For example, exports from the East African Community face much higher tariffs in other parts of Africa than outside the continent. So the CFTA’s elimination of tariffs and nontariff barriers will improve development pros- pects for East Africa, allowing the region’s firms to tap into rapidly growing markets elsewhere in Africa.

The CFTA is not only about trade, but also about creating access and free movement of people, goods, and services. Liberalizing intra-Africa services trade could bring great benefits for East Africa. Tourism is one area of growing Intra-Africa trade in services. With intra-Africa migration on the rise, the Agreement on Free Movement of Persons, which was signed by only half of African Union member states, is particularly important. A more open continental labor market would go far in addressing the skill shortages that constrain growth in strategic sectors.

If the CFTA is fully realized, the value of East Africa’s exports to the rest of the continent would increase by 31 percent, with processed food and manufacturing products the main beneficia- ries. In East Africa, only a quarter of agricultural trade is processed, compared with two-thirds of intra-Africa exports. Greater exports to the rest of Africa from East Africa could boost demand for processed foods. The welfare gains from reduced costs for goods and services due to the CFTA would total $1.4 billion for East Africa. All this will be achieved at a very small fiscal cost to the region, with tariff revenue reduced an average of just 4 percent, or less than 1 percent of total government revenue.

Crucial next step are to develop national and regional CFTA implementation strategies that complement broader trade and industrialization policies and to identify key opportunities and con- straints in order to take full advantage of the continental market. Thus, regional economic commu- nities in the region — particularly the East African Community, the Intergovernmental Authority on Development, and the Indian Ocean Commission — need to take the lead in reaching this objective.

Source: UNECA 2019.

PART

POLITICAL ECONOMY OF REGIONAL

INTEGRATION

PROGRESS IN REGIONAL INTEGRATION

Progress in regional integration in East Africa varies widely across the three RECs. The EAC is approaching the highest stage of regional integration, followed by COMESA and IGAD. This section discusses progress in regional integration in East Africa start- ing with the more advanced RECs that are moving toward a monetary union. It then covers progress toward a free trade area, a customs union, and enhanced intraregional trade. It concludes by summarizing overall

country performance in advancing regional integration.

Progress toward monetary union in the Common Market for Eastern and Southern Africa and the East African Community

East Africa has made considerable prog- ress in regional integration over the past few years. The EAC is leading this progress, fol- lowed by COMESA and IGAD. The EAC’s rat- ification of the protocol for monetary union is one indicator of this progress — and is import- ant because macroeconomic convergence

C

ountries in East Africa are members of three important RECs: COMESA, the EAC, and IGAD. All East African countries except Somalia and Tanzania are members of COMESA;

Seychelles is also a member of the Southern African Development Community, as is Tanzania;

Burundi, Kenya, Rwanda, Tanzania, and Uganda are also members of the EAC; and Djibouti, Eritrea, Ethiopia, Kenya, Rwanda, South Sudan, Sudan, and Uganda are also members of IGAD, as is Somalia (figure 3). This overlapping membership is motivated primarily by regional political alignment and economic interests and does not seem to cause major problems in regional integration development because the RECs tend to focus on the special needs of parts of the region. The EAC aims to push the regional integration agenda to its highest stage, while IGAD focuses on conflict and conflict resolution. Geographic diversity is a basic challenge in finding a common regional agenda, and it factored into the formation of RECs such as IGAD.

“But, these ‘push factors’ are largely offset by long-running tensions and conflicts stemming from colonial experiences.”³⁶ In short, the choice to set up a REC could also be motivated by domestic politics, and so REC institutional designs reflect both desired goals and intended constraints.³⁷ Domestic politics could be influenced by the consequences of these choices.

Given the importance of RECs in East Africa, a focus on the three RECs, cognizant of their historical formation, offers a general picture of regional integration there.

2