Blog
Apres La Chute

by David Fielding

Monetary Union in Africa

In the last ten years, there has been much debate about the economic impact of monetary union, in which several countries share a single currency and a single central bank. The main focus of attention has been the newly formed European Monetary Union, the economic impact of which-given its short life-is largely a matter for speculation. But monetary unions are by no means a new phenomenon. At the end of the Second World War, with the European empires largely intact, many economies around the world participated in monetary unions based on the Pound Sterling, Escudo, Guilder and Franc.

As the various colonies achieved political independence, most of these monetary unions were dissolved, the new nation states preferring complete economic independence, with their own currencies and independent central banks. Economically, they distanced themselves from each other as well as from their former colonial rulers. However, francophone Africa was an exception. Here, most of the new nation states newly chose to retain close economic links with France, retaining the shared currency of French colonial Africa.

Today, there are 14 African countries participating in the system that evolved from this post-colonial arrangement. These are grouped into two single-currency areas: the West African Economic and Monetary Union, UEMOA (Benin, Burkina Faso, Cote d'Ivoire, Guinea-Bissau, Mali, Niger, Senegal and Togo) and the Economic Community of Central African States, CEMAC (Cameroon, Central African Republic, Chad, Congo Republic, Equatorial Guinea and Gabon). Together, the two areas make up the African Financial Community (CFA). In each area there is a single central bank issuing a single currency, each of which - somewhat confusingly - is called the CFA Franc. Both of these currencies were pegged to the French Franc, and are now pegged to the Euro, at a fixed rate. The French Treasury guarantees the convertibility of the currencies at this fixed rate, on the basis of a system of rules designed to limit the amount of money printed by each central bank.

The CFA delivers a level of financial stability that is unknown across most of Africa. Historically, inflation rates in the CFA have been no higher than those in France. Capital has flowed between the CFA and the European Union with few restrictions, and without destabilizing capital flight episodes that have affected other developing economies. So other countries in the region are starting to take an interest in monetary union. Several non-francophone members of ECOWAS, including Ghana, Nigeria and Sierra Leone, have established a timetable for creating a third monetary union of their own, with the express aim of eventual amalgamation with the CFA.

However, the CFA has experienced problems of its own. In the opinion of many (but not all) economists, the CFA currencies became increasingly overvalued in the 1980s. Several of the larger member states experienced persistent balance of payments deficits, and became increasingly indebted over the decade. In January 1994, under pressure from the Bretton Woods institutions, both CFA currencies were devalued against the French Franc. The value of the African currencies was halved overnight. Despite early predictions of its demise the CFA has remained intact, with no subsequent devaluation. It has even gained an extra member, Guinea-Bissau. Nevertheless, the devaluation episode has led some to wonder whether the current system, which owes its existence, structure and scope to the historical accident that was the French Empire, is appropriate for African economies in the 21st century. This has been the focus of a recent research project at WIDER.

Is the CFA an 'Optimum Currency Area'? 

One question that the research project tackles is whether the current alignment of countries into two separate monetary unions suits the needs of today's member states. The division of the CFA into two areas provides a great deal of potential flexibility in the system. Because the French Treasury maintains the CFA-Euro peg, the two central banks are free to decide on their own short-term interest rates. In the long run, the financial integration between France and the CFA means that rates cannot diverge too far from those in Europe, but in the short run rates can be adjusted to meet local needs; moreover, interest rates in the UEMOA can diverge from those in the CEMAC, so the system can accommodate differences in economic conditions between the two regions.

However, the division of the CFA into the UEMOA and CEMAC regions is the result of an historical accident: they represent - roughly-t wo administrative divisions within the French Empire. The grouping of countries was not based on an economic rationale. Moreover, not all CFA countries were equally happy with the idea of devaluation in 1994: it has been suggested that some countries in each monetary union were more in need of the devaluation than others. Could there then be a rationale for re-forming the CFA into groups of countries based on economic characteristics? If the unthinkable ever happens, and former British colonies are incorporated into the system, how many groups should there be, and which countries should they contain?

However, CEMAC countries are mostly petroleum exporters, and UEMOA countries are all petroleum importers. This is the most important factor in determining the degree of similarity in the way different countries' economies evolve over time; so-with one or two possible exceptions-there is little to be gained from restructuring the CFA. Nevertheless, the CEMAC countries do exhibit more macroeconomic diversity than their UEMOA neighbours. This means that they may face higher costs from membership of a single-currency area with a single interest rate. It also underscores the potential difficulties that would arise if petroleum-exporting Nigeria were to be incorporated into the system.

CFA member states are aware of the potential costs of economic misalignment. The UEMOA countries in particular have sought to increase the degree of economic convergence between them by adhering to a 'convergence pact' designed to bring about a degree of homogeneity in the levels of public borrowing, external debt and inflation in each country. Our research indicates that so far the convergence pact has had little impact on UEMOA members' economic conditions, and that there is still a long way to go before the same interest rate is appropriate for all.

How has Monetary Policy Evolved Since the Devaluation?

Aside from striving for greater economic convergence, the CFA has instituted substantial reforms in the way that the central banks intervene in each economy. Before the devaluation, the central banks' activities were largely limited to the allocation of credit to different sectors of each economy, and to setting the overall rate of monetary growth within the union. Since then, the central banks' role as a source of credit to the private sector has been greatly diminished, and the use of the interest rate as a monetary policy tool has attracted more attention. For a long time in OECD countries, the setting of interest rates has been the main way in which a central bank tries to minimize the cost of economic fluc- tuations; but in Africa, where financial markets have been much smaller, the active use of the interest rate as the central bank's main policy instrument is not the norm.

Our research suggests that the CFA now uses the interest rate in a proactive way. While in the long run CFA interest rates have to match those in Europe, short-run movements in overall inflation across the region and in public sector borrowing are matched by interest rate adjustments. The rules that guide interest rate decisions are not as transparent as those in OECD countries, and the way in which the central banks react to changes in economic conditions is not as systematic. Nevertheless, there is some consistency in central bank reactions. If this is combined with a degree of economic convergence that makes the same interest rate appropriate for all, then there will be greater long-run economic and financial stability within the region.

Monetary Policy and Poverty

The CFA incorporates some of the poorest countries in the world. Many of the smaller countries, lying around the southern edge of the Sahara, have average income levels of less than a dollar a day per person. Our research also sheds some light on the way in which policy changes at the macroeconomic level-not only the devaluation, but also changes in the interest rate and in the money supply-impact on the poorest households in the region.

With respect to the impact of the devaluation on poverty, we find some surprising results. In many CFA countries, poor households make a living partly from the production of cash crops such as coffee, cocoa and cotton. More affluent households include people working for the government or large firms in the city.

Many expected the devaluation to alleviate poverty, because it increased the domestic value of cash crops relative to urban wages, and to the cost of the goods and services the urban sector produces. However, this picture is too simplistic. In some countries the devaluation made many poor households, and especially poor urban households, worse off. One explanation for this is that many of the urban poor are employed in small informal sector firms owned and financed by more affluent formal sector workers. The reduction in the real value of formal sector wages may well have had a knock-on effect on the urban poor that led to an overall increase in the incidence of poverty.

It also seems that living standards among the poor, in some CFA countries at least, are particularly sensitive to large changes in the money supply or the interest rate. This is because inflation in food prices is more sensitive to monetary policy than inflation in the prices of other commodities: in the short run food prices are more flexible than other prices. Because food makes up a larger fraction of the money spent by poor households, they face more substantial changes in the cost of living after a monetary policy adjustment.

In many ways, the CFA represents a successful programme of regional co-operation, and of economic co-operation between Africa and Europe. However, the financial stability that CFA membership brings comes at a cost, because of the wide diversity of economic conditions faced by different regions and different income groups, which are all subject to a single policy regime. The future success of the CFA depends on the recognition of this diversity, and on steps taken to alleviate the resulting costs.

David Fielding is Professor of Economics at the University of Leicester, and the director of the WIDER project Long-term Development in the CFA-zone Countries.