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Costs and Benefits of the CFA Franc

By Issiaka Coulibaly

The CFA franc zone is an economic and monetary area composed of two completely separate and independent unions: the West African Economic and Monetary Union and the Central Africa Economic and Monetary Community. The countries in this zone are mostly former French colonies that, after independence, signed monetary cooperation agreements with France. The agreements have two main implications: They guaranteed the convertibility of the CFA to the French franc (the euro since 1999) and pegged the CFA franc to the French franc, and later to the euro. In return for the CFA franc guarantee, members of the zone had to deposit at least 65 percent (recently renegotiated to 50 percent) of their external reserves into special accounts held by the French treasury.

Recurrent Debate

The terms of the CFA agreements have been a subject of debate among economists, politicians, and pan-African activists since they were signed. Indeed, after more than half a century of existence, it is not clear that this currency is favorable to the economies of the countries that have adopted it. This debate has been revived in recent years, especially after the population’s fears were heightened by a rumor, in early 2010, that there would be a devaluation of the CFA franc. Then in 2015, at the 55th anniversary of his country’s independence, Chadian President Idriss Déby Itno argued that the current principles of the CFA franc constitute an obstacle to the development of the member countries of the CFA zone. He called for the revision of the clauses of monetary cooperation with France. Economists, like the former minister of Togo Kako Nubukpo, also put forward economic arguments to denounce the CFA Franc system. They argued that anchoring the CFA franc to a strong euro reduces the competitiveness of African economies and favors imports from countries with weak currencies, like China. They also criticized the underfunding of CFA economies and the sub-optimal use of their excess foreign exchange reserves in “operation accounts" in the French treasury. This year, pan-African activists seeking monetary sovereignty organized protests against the CFA Franc on Jan. 7 and Feb. 11.

There are different costs and benefits of the CFA zone membership, many of which have been explored in existing literature. Additionally, there are multiple plausible futures for the CFA franc, especially in West Africa.

Costs and Benefits

The main problem with the CFA franc system stems from what is called “double anchoring,” where the currency is first anchored at the country level when the members are gathered into regional monetary unions, and then anchored again to the currency of an external source. Indeed, the anchoring of the CFA to the euro no longer has the same meaning, nor does it serve the same interests as it did when the system was established. Exports from the CFA zone to the euro area fell from 50 percent to 25 percent in the last 20 years in favor of exports to countries such as China, Nigeria, India, and Thailand. Thus, the benefits in terms of exchange rate stability with the euro area are ineffective because there is less trade between the two areas. Additionally, export earnings are generally reported in dollars, which the countries of the CFA zone must convert into euros. Generally, an appreciation of the euro against the dollar reduces the value in terms of exports earnings in the CFA member countries. Moreover, by choosing to peg the CFA franc to the euro, the central banks of the CFA area must follow the policies adopted by the European Central Bank in order to maintain the parity level between the two currencies. Thus the restrictive policy of the central banks of the CFA zone, decried by several economists, is mainly linked to the anchoring of the CFA franc. The strong appreciation of the euro in the 2000s was also detrimental to the economies of the franc zone. It led to the appreciation of real exchange rates in nearly all CFA zone countries and a decline in competitiveness. It is only because of the significant increase in the terms of trade, due to the rise in the price of commodities, that these countries have been able to recover and avoid further devaluation. However, the CFA member states have suffered from a structural current account deficit since the introduction of the euro.

Another difficulty for the CFA zone is that the geographical region is far from what is called an "optimal currency area," that is, a currency zone in which benefits of sharing a currency could be higher than costs. Indeed, in spite of a common currency, the intra-regional trade within West Africa and Central Africa’s monetary unions is lower than 20 percent of total trade—compared to more than 60 percent within the euro zone. The CFA member countries are also characterized by asymmetric shocks—particularly supply shocks—and the zone is less integrated financially. In terms of competitiveness level, measured by exchange rate misalignments, there is a huge difference between the countries in the zone, making it impossible to set up a single and consensual monetary policy.

The CFA zone doesn’t only have disadvantages. Recent empirical studies have highlighted that the growth rate in the CFA zone is not significantly different from that of other countries with a comparable level of development. Other authors have highlighted that CFA zone members benefit from lower inflation and better fiscal discipline compared to similar developing countries, particularly other sub-Saharan African countries. But this relative stability has not resulted in increased attractiveness of the area for foreign investors.

It is difficult to observe the benefits of the CFA zone, particularly in terms of growth, because the monetary union has not been accompanied by a significant increase in commercial and financial integration among member countries. The economies of the CFA zone are also under-financing due, in particular, to the restrictive policies of their central banks. Indeed, the level of financial development (the ratio between M2—a measure of money supply—and GDP) is 26 percent for the West African Economic and Monetary Union and 16 percent for the Central Africa Economic and Monetary Community, which is much lower than in other regions in Africa. Some believe that the active use of foreign exchange reserves will partially solve this problem.

What Future for the CFA Franc?

The future of the CFA franc is the responsibility of the Africans. It will depend on the political will of decision-makers and the population’s desire for emancipation.

In the short term, a revision of the Monetary Cooperation Agreements with France is needed, as was the case in 1973 after the criticisms of Togolese President Gnassingbé Eyadéma. Those changes transferred the headquarters of the central banks to Africa and reduced the role of France in their boards of directors. Future revisions must eliminate the aberrations of the system, such as the non-convertibility of the two CFA francs. They should shed light on the management, opaque until now, of the operation accounts held by the French treasury while facilitating the use of surplus reserves. Concerning the fixed parity, an intermediate solution is to anchor the CFA franc to a basket of currencies. This reduces the exposure of the countries to a strong appreciation of one anchor currency and allows more flexibility in monetary policy.

In the long run, the monetary future of African countries lies in monetary integration projects within the Regional Economic Communities. The Economic Community of West African States (ECOWAS), which includes West African Economic and Monetary Union countries, has the most advanced monetary integration project on the continent. For the new regional currencies in Africa, it will be necessary to avoid reproducing the same errors as those of the CFA system. More precisely, the authorities must take the necessary measures, in particular through the development of the financial sector, to allow these currencies to fluctuate freely while remaining convertible.

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Issiaka Coulibaly is an assistant professor in the Faculty of Economics and Management at the University of Bamako in Mali. He is a specialist in economic integration in Africa and international consultant for several institutions including UNCTAD and ITC.

[Photo courtesy of Zenman]

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