By ADAM IHUCHA The East African Monday, January 3 2011 Some two years ago, Tanzanian investors interested in buying into the massive initial public offering of Kenyas largest mobile telecommunications company, Safaricom, were locked out by their countrys regulations and could only look on as their counterparts in Rwanda and Uganda took part. A year later, the National Microfinance Bank of Tanzania also had an IPO on the Dar-es-Salaam Stock Exchange but investors from other East African Community partner states Kenya, Uganda, Rwanda and Burundi were not allowed to buy the shares. The countrys capital account regime prohibits flow of foreign investments into the country. It is these regulations that have landed the countrys financial sector with the unenviable tag of the most rigid in the region, in a new study by International Monetary Fund that also delivers a harsh indictment of its stultifying effect on the regions efforts towards monetary integration. The new report, contained in the IMF working paper on Measuring financial barriers among the three EAC founder member states a copy of which has been seen by The EastAfrican ranks Kenyas financial sector as the most flexible and open in the region, followed by Uganda, and finally Tanzania. With the coming into force of the Common Market protocol, the EAC now has its sights trained on the Monetary Union expected to come into force in 2012, which requires openness in the partner states financial systems. The other EAC partner states of Rwanda and Burundi were not covered in the IMF paper, prepared by Yi David Wang, which was published early last week. Mr Wang used the covered interest rate parity (CIP) and forward foreign exchange (FFE) systems to measure the regions financial openness. CIP refers to a principle stating that yields from two equivalent investments in the domestic market and the foreign market, respectively, are equal after accounting for fluctuations in the exchange rate. On the other hand, FFE is an agreement that obligates an investor to deliver a specified quantity of one currency in return for a specified amount of another currency. According to the paper, Tanzania contains a number of explicit capital movement restrictions that may impede CIPs functioning. For example, Tanzania restricts non-residents from borrowing abroad and restricts the participation of non-residents in the domestic money market. Available data indicate that Tanzania is the only country in EAC that restricts outward direct investment. The same applies to the aspect of purchase of foreign securities by residents, whereby Tanzania only allows purchasing of foreign securities using externally generated funds. This is not the case in Kenya, Uganda and Rwanda, while in Burundi it only requires the approval of the central bank. In the same vein, Tanzania restricts its citizens participation in foreign capital markets, including in IPOs floated across the border. The sale or issue of securities abroad by residents is also restricted, unless approved by the Capital Markets and Securities Authority (CSMA), while in Kenya and Uganda there is no such bureaucracy. The purchase of bonds and other debt instruments locally by non-residents is restricted in Tanzania but not in other partner states. Tanzania does not allow non-residents to sell or issue debt securities in the domestic market but the same is allowed in other partner states. To achieve financial integration, barriers to international movement of capital across national boundaries need to be removed. Free capital movement across national borders among countries with different currencies requires the integration of foreign exchange and money markets. In synopsis, the IMF paper calls upon EAC members to remove or lower their existing financial barriers to facilitate integration. The governor of Bank of Tanzania, Prof Benno Ndulu, told The EastAfrican in Arusha last week that Tanzania will liberalise its capital account within the East African trading bloc by 2012 and 2015 for the rest of the world. This is in accordance with one of the annexes of the EAC Common Market Protocol that came into force in July 2010 a requirement for all partner states. This, experts say, will enhance investor confidence, encourage trade among EAC partner states, and facilitate the growth of the foreign exchange market and flow of foreign direct investment. According to Prof Ndulu, the Tanzanian position on the capital account was underpinned by fears of capital flight but now the situation has changed as investments into Tanzania from the region grow rapidly. The first BoT governor of independent Tanzania, Edwin Mtei told The EastAfrican in Arusha that the CA liberalisation delay is absolutely absurd. Mr Mtei said in the current situation, virtual capital flight cannot be controlled, while local investors can use agents to buy shares across the borders. Against the background of highly volatile international capital flows and the associated financial instability experienced by a number of major emerging market economies in recent years, the role of the IMF in capital account liberalisation has been a topic of major controversy. Analysts say the IMFs role is particularly controversial because capital account liberalisation is an area where there is little professional consensus. Moreover, although this liberalisation is among the IMFs official purposes outlined in its Articles of Agreement, the IMF has no explicit mandate to promote it. Indeed, the Articles give the IMF only limited jurisdiction over issues related to the capital account. Nevertheless, the IMF has given greater attention to capital account issues in recent decades, in light of the increasing importance of international capital flows for member countries macroeconomic management. In view of these facts, an independent assessment of how the IMF has addressed capital account issues seems warranted.