Integration of the Ethiopian Financial Service Sector through regional financial arrangements: a step before the WTO accession?

• Author: Ghebregergs, Mehreteab Ghebremeskel

Abbreviations

AEC- African Economic Community

AfDB- African Development Bank

CBE- Commercial Bank of Ethiopia

CM- Common Market

COMESA- Common Market for Eastern and Southern Africa

CU- Customs Union

EAC- Eastern Africa Community

FTA- Free Trade Agreement

GATS- General Agreement on Trade in Services

GDP- Gross Domestic Product

GTP- Growth and Transformation Plan 2010/11-2014/15

IGAD- Inter-Governmental Authority for Development

LDC- Least Developed Country

MERCOSUR- Mercado Comun del Sur (Market of the South- trade cooperation among Southern American Countries)

MFI- Micro Financing Institution

MFN- Most Favored Nation Treatment

MU- Monetary Union

NBE- National Bank of Ethiopia

OECD- Organ

PTA- Preferential Trade Agreement

RFI- Regional Financial Integration

RTA- Regional Trade Agreement

SADC- Southern Africa Development Community

SDT- Special and Differential Treatment

WTO- World Trade Organisation

1. Critical Examination of the Benefits and Challenges that may Emanate from RFIs Constituted of Developing Countries and LDCs (3)

   Regional integrations can take different forms based on their nature and/or depth. It can be a political, social or economic integration or any combination of those. In addition, based on the depth, integration can range from the lower preferential trade agreement (PTA) to political and economic union. In between are placed free trade agreements (FTA), customs unions (CU), common markets (CM) and economic and Monetary Unions (MU). (4)

   RFIs among developing countries, which proliferated even in the presence of multilateral agreements on the area, offer several benefits for members if properly run. However, such integrations face multiple constraints that affect their beneficial uses.

   1.1 Benefits derived from RFIs Constituted of Developing Countries

   The positive effects of trade agreements go beyond the economic benefits. Security issues are some of the reasons for joining RTAs. Coulibaly cited sources to conclude that RTAs reduce the risk of conflict within a region. (5) In addition to the peace and security, they can also promote exchange of cultures and civilization among the community members.

   The commonly cited economic benefit of RTAs among developing countries is the economies of scale that comes due to increased market access. This is one of the major reasons for integrations in Africa (6), where domestic economies are characterized by small markets. RTAs reduce tariff and non-tariff barriers among members that ease the difficulties business persons could face in trading activities. Integration unleashes the production, export and consumption potential. By increasing investment, production and trade, it helps reduce poverty.

   On the other hand, where there are regional institutions that supervise or regional laws that govern trade activities, the need for making several national laws and standards and establishing many national financial institutions decreases. This is very essential for LDCs with infrastructural and financial constraints. (7)

   RFIs among developing countries put demands on members to follow standards which go in line with their economic status. Mode 4 financial liberalization which requires movement of persons and labour under RFI, for instance, put labour standards, which are less burdensome in RFIs among countries with less developed economies. (8)

   RTAs also help members to have more negotiating power in continental or multilateral negotiations by establishing common stand. This is one of the objectives included in EAC (9) and COMESA. (10) On the other hand, governments can use commitments in RFIs to defend protectionist stands in their home countries.

   The other benefit is the added commitment governments show to stick to reform plans. RFIs among developing countries, similar with the effects of joining the WTO, work to improve the legal and institutional frameworks of a member country. These commitments in RFIs bring more accountability on the part of governments to stick to reforms. For instance, a monetary union aims at avoiding exchange rate instability and achievement of macroeconomic stability. (11) This harmonization reduces the costs of doing business resulting in wider provision of financial services. (12) Furthermore, when RFIs have dispute settlement organs, investors have more confidence in the regional forums than national ones.

   RFIs promote efficiency in the economic field by opening up competition and movement of capital and people. Transfer of technology, know-how and show-how, and managerial skills can also be facilitated through RFIs. This reduces the major constraints in trade in financial services such as lack of information, managerial skills and technology. (13) They also benefit consumers by offering them cheaper and higher quality products and services. With this understanding, EAC has made competition in the financial service sector a basic strategy in the financial service sector. (14)

   Researches indicated that the south-south trade integration have brought trade related benefits to their members. (15) Some other researches showed that integration among developing countries brings no less benefit than an integration between developed and developing countries. (16)

   Despite all the benefits, trade among developing countries have been described as minimal. It accounted for 6% of all trade on merchandise and 10% of all trade in services. (17) This shows how big the space is for increased integration among developing countries. Most of RFIs have failed to meet many of their objectives, particularly the objective for deeper integration. (18) The next section briefly analyses the problems of financial integration among developing countries.

   1.2 Challenges Faced by RFIs Constituted of Developing Countries

   Dependence on import-export taxes as means of revenue has created countries not to commit lest they lose the immediate revenues. (19) Hence, developing countries may be more concerned about the loss of revenues because of integration than the medium or long term benefits of integration. This is of special importance for member countries of COMESA, where trade taxes constitute more than 10% of national fiscal revenues. (20) In addition, the difficulty and cost of determination of rules of origin in integration less deep than CU might frustrate trade integration. At times, producers opt to pay the duties than incur the costs of ascertaining origin as the latter may be higher and time-taking. (21) LDCs suffer more as they lack the needed expertise. This problem is aggravated when a country is a member of two or more RTAs, a common phenomenon in Africa. (22) Membership in more than one RTA similar in nature complicates the supervision and governance of the integration in addition to the financial burden it imposes on the country.

   Poor infrastructure is another weakness of RTAs among developing countries. Poor port facilities, means of transport, communication, and technology adversely affect trade among RTA members. In general, trade among developing countries have more constraints than trade among developing and developed countries, and five times more barriers than trade among developed countries. (23)

   In African RFIs, the major problems are lack of adequate means of communication, technology, know-how, managerial skills, poor regulatory and institutional framework, poor financial sector, macro-economic instability, very restrictive financial market, presence of the public sector in the market, lack of currency convertibility, lack of political commitment and corruption. (24)

   Large size of the public sector, (25) weak economies, (26) political instability and conflicts, lack of common vision and commitment to economic integration, (27) lack of convertibility of currency, (28) problems related to rule of law and governance, (29) overambitious goals, (30) lack of compensation scheme for weak member countries, (31) and trade diversion effects (32) are some other reasons cited for weak performance of RFIs among developing countries.

   Non-complementarity of trade is also cited as a setback to deeper integrations. However, lack of trade complementarity is more relevant to trade in goods than RFIs for two reasons. First, RFIs among developing countries are characterised by weak financial institutions in member countries. Hence, there is an ample room for competition in similar services. Second, trading in similar financial services strengthens efficient and fair competition as can be exemplified by financial service trade among developed countries. (33)

   Another challenge is the issue of sovereignty. The level of sovereignty surrendered in international trade agreements differs as to the level of integration, mode of liberalisation, and presence and effectiveness of enforcement systems.

   In FTAs and CUs, which are regarded as lower levels of economic integration and has less to do with financial integrations, they mainly act as a forum of discussion taking little off the sovereignty of members. The latter takes away the power of member countries to determine rate of tariff on non-members, determination of which is made by the RTA. When there are supranational institutions established, they act as monitoring bodies only. (34)

   Significant implications on the financial sector start when the integration is transformed to a CM. By ratifying the CM, members agree to allow and guarantee free movement of services and service suppliers, commitments which they make in the four modes of trade in services. (35) The CM also requires countries to coordinate and harmonize national economic and monetary policies and to adhere to the macroeconomic convergence criteria. (36) They also need to coordinate and harmonize financial policies and regulatory frameworks for smooth operations of the payment system and ensure convertibility of national currencies in all transactions. (37)

   When it is MU, where a member country renounces its national currency, its...