From the CFA franc to the ECO, a reform for the convergence of West African economies
On May 22, 2020, the bill adopted by the French National Assembly for the creation of a single currency in West Africa followed the monetary cooperation agreement signed on December 21, 2019 between France and the Member States of WAEMU* (West African Economic and Monetary Union). This agreement aimed in particular to reform and modernise the functioning of the WAEMU franc zone, while taking into account the criticisms leveled against the disputed CFA franc.
This project covers West Africa where the ECOWAS zone (Economic Community of West African States) has 15 members1, six of which belong to the West African Monetary Zone (WAMZ), eight belong to the West African Economic and Monetary Union (WAEMU), and Cape Verde, which is not a member of either of these two organisations.
This bill contains 3 main points*:
The end of the obligation to deposit half of the foreign exchange reserves of the Central Bank of West African States (BCEAO) with the French Treasury, thus giving the BCEAO the freedom to place its foreign exchange reserves change where she wants
The abolition of French representation within the governing bodies of the BCEAO
A merger of the WAEMU and WAMZ zones for a single currency
Pending the implementation of this project, what can we say about the CFA franc?
The CFA franc seems ill-suited to African economies for five reasons:
Absence of intra-regional trade dynamics. Nearly 75 years after its creation, the countries of the franc zone continue to trade very little with each other: intraregional trade represents 15% in West Africa, while in the euro zone, it is over 60%2.
The CFA franc hinders the competitiveness of African products by acting as a tax on exports and a subsidy for imports. Countries that have the impression of having a strong currency (here the CFA) tend to import rather than produce (for example, rice is mainly imported from China). This gives rise to trade balances that are often in deficit3.
In the CFA franc zone, financing is more expensive: interest rates for loans remain particularly high and sometimes reach 15%, which reduces the volumes of loans granted to businesses and households4.
Central banks today have the sole objective of containing inflation and not of promoting growth and job creation, thus slowing down economic development5.
The fixed parity with the euro has advantages and disadvantages: it guarantees effective budgetary policies, but it makes monetary policy theoretically ineffective. It promotes economic ties between African countries and the euro zone. However, it can be problematic in the event of an appreciation of the euro against other currencies6.
In view of this analysis, what are the advantages of the new currency, the “ECO”?
Let us begin by specifying that money is not a factor of production. Standard economic models establish that it is neutral - it is not likely to stimulate long-term economic growth. The latter depends on technological progress and the growth of factors of production, such as labor or capital.
The main characteristics of the ECO are as follows7:
First, the idea is to make the ECO a currency that is at the service of transformational development to avoid the export of materials without any on-site processing.
In addition, foreign exchange reserves will be centralised with the involvement of the populations.
Finally, the common currency will be based on a basket of currencies including the euro, the US dollar, the yuan and the pound sterling.
Mr. Diakaridja KONE, Head of the Analysis and Research Department at Joseph & Daniel Advisory, comments: “We believe that the reform of the regional currency is necessary in the context of the development of the WAEMU financial market. Indeed, the ECO should encourage the arrival of new sub-regional investors on our market (outside WAEMU) who will no longer be subject to currency risk. Consequently, the reform would have a positive impact on the depth of the financial market for government bond issues, as well as on the overall liquidity of listed securities”.
What will this entail for WAEMU countries?
There should be no major short-term consequences for monetary stabilityin the WAEMU. Indeed, the fixed parity with the euro, as well as its convertibility guarantee, will still be provided by the Banque de France in the short term*.
Maintaining the fixed parity with the euro has advantages8:
It allows exporters and importers in both zones to protect themselves from currency risk. This should encourage financial and commercial flows.
A guarantee of unlimited convertibility granted by France is also a reassuring factor for investors as to the security of their investments and profits in the face of the risk of a currency crisis.
A peg to the euro ensures good price stability.
Eventually, the ECO will have the same advantages and disadvantages as the CFA franc. Defenders of the ECO emphasize the low risk of an exchange rate crisis and moderate inflation. Indeed, the WAEMU will continue to enjoy the benefits of being associated with a so-called "strong" currency, the euro, which makes imports relatively less expensive. The purchasing power of consumers in WAEMU countries benefits from this system.
On the other hand, opponents to this system of fixed parity with the euro will insist that it deprives WAEMU countries of their monetary sovereignty and in particular of the instrument of competitive devaluation. Tied to the Euro, it is no longer possible to lower the external value of their currency in order to stimulate exports and reduce imports, although this would encourage local production.
Mr. Diakaridja KONE shares this concern: "From our point of view, the issue of currency flexibility seems necessary because if the fixed XOF/EUR parity currently makes it possible to contain the inflation rate in the WAEMU zone, the adoption of a flexible exchange rate system with the ECO should stimulate industrial transformation and the economies of the States in the zone thanks to the monetary policy that currency flexibility should make possible”.
Some economists argue that in the long term, this reform of the CFA franc could also delay the implementation of the monetary integration project among the 15 ECOWAS countries. This project aims to provide ECOWAS countries with a single currency in order to facilitate trade and economic integration in the region, an objective not achieved to date by the CFA franc, as mentioned above.
Marie-Antoinette Nzebo, Head of Societe Generale Securities Services (SGSS) Côte d'Ivoire, added that the ECO may not be the solution to all the problems faced by the CFA franc, but it is indicative of a long-term trend toward the internationalisation of West African financial markets. While the last two years have shown a relative caution on the part of international investors in the subregion9, this should not call into question the growing flow of foreign capital into West Africa over the long term and SGSS Cote d'Ivoire is now the custodian of reference for international investors10.
Jean-François Marchand, Country Relationship Manager Africa, Societe Generale Securities Services