A single African currency in our time? The goal of a single market underpinned by a common African currency remains an ultimate objective of African unity. But wishing for a common African currency and achieving it are two very different things. Moin Siddiqi looks at the benefits and pitfalls of a common currency.
In August 2003, the Association of African Central Bank Governors announced plans to create a single African market--an area without internal frontiers in which the free movement of goods, persons, services and capital is ensured--and also establish a common central bank that would manage a single African currency by 2021.
The AU's twofold strategy entails first building genuine monetary unions in Africa's five existing regional economic blocs. These regional trading communities, embracing both Anglophone, Francophone and Lusophone Africa, represent the first stage towards 'full-blown' economic and monetary union (EMU), similar to the creation of the EU's single market in 1992.
The second more difficult stage entails mergers of five regional blocs, leading to a new supranational institution modelled on the US Federal Reserve system or the European Central Bank, and a single African currency. Such a far-reaching goal, if achieved, would radically transform Africa's politico economic landscape and place the continent on a solid footing to meet the formidable challenges of the 21st century.
Before delving into the regional monetary integration processes and the potential costs and benefits of currency unions in Africa, it would be useful to reflect on what is meant exactly by EMU.
Max Corden, in Essays in International Finance, published in 1972, defined monetary integration in terms of "exchange-rate union, that is, an area within which exchange rates bear a permanently fixed relationship to each other ... and total convertibility", or as he put it "the permanent absence of all exchange controls, whether for current or capital transactions, within the area."
EMU is therefore an area where one currency prevails, or initially several currencies freely convertible at irrevocable fixed exchange rate circulate within the zone, and where a single institution is responsible for controlling the area's money stock and monetary policy (ie setting interest rates, credit aggregate and inflation targeting).
This model, however, can be distinguished from two conventional forms of monetary integration. The first involves the fixing of exchange rates and the existence of financing facilities to ease money and trade adjustments and is referred to as a 'currency union'.
The second form is referred to as 'financial integration' that involves free capital mobility and the unification of the financial services industry and markets to facilitate such freedom among member states. In both models, restrictions preventing nationals of one member state from establishing themselves in another state, or providing services directly into another state, would disappear.
Building viable monetary blocs
There are currently three regional monetary unions--the West African Economic and Monetary Union (WAEMU); the Economic and Monetary Community for Central Africa (CAEMC) and Common Monetary Area (CMA) or the 'rand zone' in Southern Africa, comprising Lesotho, Namibia, South Africa and Swaziland.
The WAEMU and CAEMC are two subzones of the CFA franc zone and operate rigid exchange rate pegs to the Euro at a fixed rate of Eurol:CFA655.957.
Since 1948, the French Treasury (Tresor Public Francais) has guaranteed the CFA franc's convertibility. Currencies of CMA members are pegged to the South African rand.
The only true example of EMU in Africa is the Franc Zone system where member states share a common central bank. The Banque Centrale des Etats de L'Afrique de I'Ouest (BCEAO) issues the currency for WAEMU members: Benin, Burkina Faso, Cote d'Ivoire, Guinea-Bissau, Mali, Niger, Senegal and Togo and the Banque des Etats de L'Afrique Centrale (BEAC) issues the currency for CAEMC members: Cameroon, Central African Republic, Chad, Republic of Congo, Equatorial Guinea and Gabon. Both central banks influence domestic credit expansion by granting rediscounting facilities and direct advances to the commercial banks. The interest rate structure and banking legislation within the unions are harmonised.
But France has significant influence over Francophone Africa's monetary policy by having its representatives on the board of BCEAO and BEAC. Under the 1973 convention, each of the two central banks is allocated an operation account (OA) at the French Treasury. The latter provides the issuing banks with unlimited overdraft facilities on each OA. The WAEMU and CEMAC member states boast a proven record of low inflation and healthy public finances (see Table 1).
Another two EMU projects are at the planning stages. The 14-member SADC hopes to launch a single currency and a supranational central bank by 2016 and the five members of ECOWAS--Ghana, The Gambia, Guinea, Nigeria and Sierra Leone--have a target date (2009) of forming a 'second monetary union' as the first step towards a common 'eco' currency for entire West Africa, thus embracing eight WAEMU members.
The latter project is called the West African Monetary Zone (WAMZ). Various inter-governmental committees are overseeing WAMZ's convergence process that requires member-states fulfilling four basic criteria: a budget deficit (excluding grants) of not higher than 5% of GDP; central bank financing of budget deficit must not exceed 10% of the previous year's tax revenue; single-digit inflation; and gross forex reserves of at least three-month imports.
There are practical difficulties with both projects. Many SADC members are economically diverse from each other. The financial systems (except in South Africa) are generally underdeveloped and the shares of manufactures in production and exports are low. The correlation of terms of trade shocks between the principal country (South Africa) and the other 13 SADC members are lower.
In West Africa, Nigeria's oil-based economy differs markedly from its neighbours, which export non-fuel primary commodities (notably cocoa, cotton and gold) and are, therefore subject to different price adjustments. West African countries would need more time to bring about a convergence of their national policies as well as harmonise banking regulations and institutions.
There is also a question mark over the future status of the CFA franc zone in the post Ecowas monetary union era. The WAEMU members may have to abandon their historical ties with France. The European Council stipulates that Paris must obtain the Council's approval for any amendments to exchange rate agreements with Francophone Africa. The EU is unlikely to endorse an expansion of either French guarantees to Anglophone countries nor for the European Central Bank to replace the French Treasury as a guarantor of convertibility.
To date, insufficient research has been available on the feasibility and desirability of a continent-wide currency union. Professor Paul Masson and Catherine Pattillo, in their 2004 book The Monetary Geography of Africa, discuss this topic in depth. Painstaking research showed that only two of the five regional economic blocs (Comesa and Ecowas) would gain on average from a single currency. Both regions have the heaviest funding needs in proportion to their GDP.
By contrast, the regions boasting prudent fiscal policies (AMU, ECCAS and SADC) would not gain, on average. Within SADC, South Africa (the largest economy), would face large welfare losses.
For all the regions, overall intra-African trade is extremely low at 10% of their total, suggesting that the gains from a single currency through lower transaction costs may be limited.
Generally, poor communication and transport links between many African countries deter intra-regional trade and increase 'cross-border' business costs.
The technicalities of tighter monetary integration, fixed exchange rates, central control over monetary/fiscal policies and the eventual creation of a single African Central Bank are important issues that require strong institutions at both domestic and regional level.
In Africa, the low institutional capacity presents an obstacle to EMU goals. Outside the franc zone, existing national central banks (except the South African Reserve Bank and the Bank of Botswana) are not independent, and several Anglophone countries have often suffered from spiralling inflation because the central banks were compelled to finance budget deficits and annual subsidies paid to parastatals.
Co-authors Masson and Pattillo comment: "A critical question for Africa is whether the creation of a regional central bank can be a vehicle for solving the credibility problems that bedevil existing central banks. If so, establishing an independent central bank that exerts greater discipline over fiscal policies than national central banks do may enable it to become an agency of restraint."
The road to the European EMU was not easy--it took over four decades to realise the Treaty of Rome's goals of regional integration. The project involved a step-by-step process of bloc expansion: the narrowing of exchange rate margins to 2.25% among participating member-states; creation of a medium-term pool of foreign exchange reserves; active coordination of short and medium-term economic and budgetary policies; creation of the European Monetary Cooperation Fund and Regional Development Fund and harmonisation of taxes.
A single currency, the euro, was finally introduced on 1 January 1999. So if the process of forming the European EMU was formidable and time-consuming, even with a strong political will and efficient bureaucracies, then, realistically, the challenges for Africa are even greater.
Benefits and costs of currency unions
Europe's EMU serves as a model for the regional economic integration of African countries.
In essence, once EMU or a single currency has been established, producers, traders and consumers will be permanently better off operating under a much-improved regime.
The most tangible benefits are likely to accrue through a reduction of transaction costs and exchange rate uncertainty. For businesses, a single currency eases transaction costs linked with conversion, resulting in savings in both time and money.
Greater currency stability also promotes intra-regional trade and simplifies business decision-making processes by relaxing this very real constraint. That is because exchange risks discourage cross-border trade and investments. The longer term a business project, the more its planning is affected by currency concerns.
JA Frankel and AK Rose in An Estimate of the Effect of Common Currencies on Trade and Income, show that trade between two countries within the same currency union is three times greater than it would be if using different currencies.
A wider regional integration could help Africa in negotiating preferable trading terms either bilaterally (with the US and the EU) or globally in a World Trade Organisation context.
Currency unions can spur the development of a single market in trade, finance and investment. Transnational corporations targeting regional manufacturing and service sectors should find lucrative opportunities in a larger market that provides scope for economies of scale and production efficiency. That, in turn, will improve Africa's prospects of attracting higher foreign direct investment (FDI) for sectors other than mining and hydrocarbons.
A single currency would enhance monetary co-operation within sub-regional banking sectors, leading to improved payments and clearing systems. The other potential long-term gains are macroeconomic stability, as a common central bank is able to introduce anti-inflationary measures more efficiently. It seems indisputable that a single monetary zone leads to reliable fiscal control mechanisms.
The revenue from 'seignorage' (i.e., resorting to the printing press) to finance chronic budget deficits creating a ballooning money supply situation and soaring inflation, will no longer be an available policy option.
The consequence of fiscal prudence is that it enhances the credibility of the government's policies, while macroeconomic stability facilitates more efficient allocation of resources in member states, underpinning sustained growth and increased job creation as well as deterring capital flight from the region.
To sum up, substantial gains are anticipated from sounder economic policies, improved business competitiveness, a simplification of procedures and greater transparency in pricing at the sub-regional level.
The potential costs of EMU are more complex and difficult to evaluate. However, the most significant cost derives from the loss of autonomy over macroeconomic policy. Under an EMU, member states must relinquish an important adjustment instrument for balance of payments, since the option of currency devaluation or revaluation is removed from individual countries.
A new supranational central bank assumes responsibility for key aspects of policies, such as the future direction of interest rates and nominal exchange rate adjustments.
By contrast, an independent monetary stance (ie a policy of flexible exchange rates) enables a country to determine its own rate of inflation and deal with unforeseen exogenous shocks. Moreover, unified monetary blocs will necessarily involve greater integration and co-ordination between individual countries' fiscal policies and impinge directly on matters of political sovereignty and control over taxation and public spending.
The system imposes budgetary rules because an excessive budget deficit in an individual member country can undermine the zone's exchange rate stability.
This, in turn, could subject other participants to 'external dis-economies' through hikes in the average community interest rates and by the 'crowding out' of some private sector investment.
Also, the system of fixed exchange rates could in times of market turmoil call for steep rises in interest rates to preserve a single currency's stability. Guillaume and Stasavage, in Is There a Case For African Monetary Union?, argued that monetary integration can underpin financial stability, contingent on three conditions: exiting the union would incur loss of other benefits, like access to regional industrial/social grants; governance structures must be designed to enforce monetary rules and greater fiscal discipline and unwise policies by one country to undermine the union's rules must be collectively opposed by others.
A common currency: reality or myth?
The creation of a single market will symbolise the achievement of true regional integration. While general principles are valid, however, the timetable of attaining the single market by 2021 appears unrealistic. The considerable variations in the performance of sub-regions constitutes a real drawback to achieving a European-style EMU. In reality, not all countries are keen to join a currency union because of differences in economic structures.
A single African currency remains a distant prospect. However, Etienne Yehoue of the IMF Institute believes: "It will happen very slowly in Africa. When you look at the degree to which economic policies converge, it is not very encouraging. Nevertheless, if there is a strong political will, it is not impossible for this to occur in the future."
At best, in coming years, there should be some modified form of greater regional cooperation, based on either currency unions or financial integration. In today's competitive global markets, only larger trading blocs can compete effectively for inward investment and foreign trade. Regional solidarity--like in post-war Europe--will contribute to sustained political/economic stability within the continent and raise Africa's standing in the world economy, as well as improving its capacity to withstand exogenous shocks.
RELATED ARTICLE: Africa's regional economic blocs
The Arab Monetary Union (AMU)
comprising Algeria, Libya, Mauritania, Morocco and Tunisia.
Common Market for Eastern and Southern Africa (Comesa)
Angola, Burundi, Comoros, Congo, DR Congo, Djibouti, Egypt, Eritrea, Ethiopia, Kenya, Madagascar, Malawi, Mauritius, Namibia, Rwanda, Seychelles, Sudan, Swaziland, Uganda, Zambia and Zimbabwe.
Economic Community of Central African States (Eccas)
Burundi, Cameroon, Central African Republic, Chad, DR Congo, Equatorial Guinea, Gabon, Rwanda and Sao Tome & Principe;
Economic Community of West African States (Ecowas)
Benin, Burkina Faso, Cape Verde, cote d'Ivoire, The Gambia, Ghana, Guinea, Guinea-Bissau, Liberia, Mali, Niger, Nigeria, Senegal, Sierra Leone and Togo
Southern African Development Community (SADC)
Angola, Botswana, DR Congo, Lesotho, Malawi, Mauritius, Mozambique, Namibia, Seychelles, South Africa, Swaziland, Tanzania, Zambia and Zimbabwe
Table 1: Key macroeconomic indicators for sub-regions, (In percent) 2001-05 (average) Fiscal Public Real GDP Consumer Balance Expenditure Growth Broad Growth Prices (%) of GDP (%) of GDP Money WAEMU 3.3 1.8 -2.2 20.7 7.8 CEMAC 7.3 2.7 2.4 20.0 12.2 SADC 3.6 15.2 -2.3 27.3 25.3 COMESA 3.7 28.7 -3.6 29.0 43.7 Sources: IMF, African Department database and World Economic Outlook, September 2005. Table 2: Potential gainers and losers from the proposed monetary unions Gainers Significant losers* Common Market for Angola, Ethiopia, Egypt, Kenya, Eastern and Southern Malawi, Seychelles, Madagascar, Mauritius, Africa: Sudan, Zambia, Zimbabwe Namibia, Swaziland, Uganda East African Community: Kenya Economic Community of The Gambia, Ghana, Benin, Burkina Faso, West African States: Nigeria, Sierra Leone Cote d'Ivoire, Mali, Niger, Senegal, Togo Southern African Angola, Botswana, Congo Lesotho, Namibia, Development Community: (DR), Malawi, South Africa, Mozambique, Seychelles, Swaziland Tanzania, Zambia, Zimbabwe The [planned] West Nigeria The Gambia, Ghana, African Monetary Zone: Guinea, Sierra Leone *Welfare losses exceeding 196 of GDP-equivalent. Source: Paul Masson and Catherine Pattillo, "The Monetary Geography of Africa" 2004.
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|Date:||May 1, 2006|
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