Two very different monetary zones, yet linked through currency

There are three “Franc zones” stemming from colonization and sharing one (though not interchangeable) currency, the CFA Franc: the WAEMU (West African Economic and Monetary Union), the CEMAC (Economic and Monetary Community of Central Africa, or EMCCA) and the Union of the Comoros. This currency has evolved in a fixed parity regime with the French Franc from 1959 (1981 for the Comoros) to 1999 before being pegged to the Euro.

This fixed parity aimed at ensuring macroeconomic stability, reducing risks of exchange rate crises, importing policy credibility and promoting intra-zone trade. It was deemed adequate given that the Eurozone is the main trading partner. Nevertheless, both monetary areas are not only suboptimal with regard to Mundell’s criteria, but are also very different from one another, as the Eurozone consists of industrialized countries and the CFA Franc is used in low-income economies. This potentially induces incompatibility of monetary policies, and therefore an inadequate policy stance in the Franc zone. The inflation target in the eurozone is 2 percent, acceptable for a group of industrialized economies, but less desirable for the Franc zone whose target of 3 percent is costly in terms of growth. Studies have clearly shown that inflation levels of developing countries between 7% and 11% stimulate production, against 2% to 3% in developed economies. However, the main goal of the three Franc zone central banks is to fight inflation with tools adapted to an inflation of monetary causes in a zone where real factors dominate: climate hazards impacting countries still very reliant on agriculture, an increase in energy prices (notably oil) and inflation imported from the Eurozone. Despite these factors, they maintain the 3% target while trying to support local economic activity.

The immediate explanation of currency overvaluation

A common challenge to all monetary zones is convergence among its economies. In the Eurozone, this convergence is still a slow on-going process—marked by diverging competitiveness, labor market trends, and external balances.[i] Within the Franc zone, a few groups of countries emerge. CEMAC economies experience trade surpluses thanks to oil exports. This similarity of production structures allows for a convergence of CEMAC members’ external trade, measured by the standard deviation of their current accounts weighted by their real GDP.[ii] In the WAEMU, Côte d’Ivoire (the largest economy) displays significant trade surpluses while other countries experience deficits, such as Senegal, often considered another WAEMU economic power.

Critics estimate that the strong level of the Euro against the US dollar is responsible for an overvalued CFA Franc that penalizes the zone’s export competitiveness. The question is whether this loss of competitiveness is simply due to the CFA Franc level, or whether other factors can be identified.

Economies with little diversification and very exposed to international competition

WAEMU global competitiveness, measured by the real effective exchange rate, has deteriorated over the 2002 – 2011 period by about 5 percent according to the BCEAO. In 2012, it improved with a decrease of 3% of the real effective exchange rate and inflation lower than its partners’. WAEMU countries are mainly commodity exporters. Between 2000 and 2004, oil, cotton, cacao, gold and precious metals represented 50% of exports and rose to 60% in the 2005 – 2011 period. In 2012, these countries recorded increasing export rates, due to the dynamism of extractive industries, with the exception of Senegal and Guinea-Bissau that lost respectively 0.2% and 1.4% in 2012 compared to 2011. The zone as a whole gained 2.1% over the period 2002 – 2011 and an additional 1.1% in 2012. On the other hand, the penetration rate for foreign enterprises progressed by 1.2% between 2001 and 2011, and an additional 3.8% from 2011 to 2012, which translates into a decrease of domestic companies’ market share, and thus a net loss of competitiveness. At the level of individual countries, foreign penetration rates increased by 11.3% in Burkina Faso between 2001 – 2011, 14.7% in Niger and 8.7% in Togo.[iii] In addition, imports are generally finished equipment and consumption products with a strong added value. Individual countries’ deficits suggest that imports outweigh competitiveness gains.

High costs of factors of production and an unfavorable business climate

Over the period 2001 – 2011, the steady increase in world oil prices strongly disadvantaged local producers. This caused a generalized price increase in oil products within the WAEMU and therefore a cumulated growth of energy prices of 33.4% in Côte d’Ivoire and 91.5% in Senegal over the same period, the weakest prices being in Benin. Different price levels among countries are chiefly due to differing tax levels. Electricity and transportation costs have equally risen. Fuel oil, used as intermediate consumption in thermal electricity production, leading to an increase of electricity rates of an approximate average of 100 FCFA.

Labor and financing costs also rose substantially. While remaining stable in Côte d’Ivoire and Senegal, minimum interprofessional wages went up by 26.5% in Benin, 50% in Niger and even 103.5% in Togo. Higher costs of factors of production have strongly deteriorated local companies’ competitiveness.

The unfavorable business climate to these higher costs. The World Bank’s 2014 Doing Business ranking, based upon the ease of doing business in a country, issues a severe judgment for the WAEMU and the Franc zone generally. First among these countries, Burkina Faso is ranked 154^th, just before Mali (155^th) and Togo (157^th). Côte d’Ivoire, the regional export champion, is only 167^th, Senegal 178^th and the Central African Republic and Chad come last, respectively 188^th and 189^th.

What policies for the future? Budgetary rigor, economic diversification and… federalism ?

Competitiveness could be restored with budgetary restraint measures aiming at minimizing situations of twin deficits in the long run. This may be difficult to conciliate with economic development imperatives, and may come at a cost for public as well as private investment, in countries that have paid the costs of structural adjustments in the past. More reforms at the regional level will be needed to ensure convergence among economies. As mentioned before and alike the Eurozone, the WAEMU is far from being an optimal currency area due to its exposure to idiosyncratic shocks and low mobility of capital and labour. The BCEAO has admittedly decided to reduce banking transaction costs in the whole zone, but federalism is certainly not underway. The WAEMU has undertaken a number of initiatives in favour of greater market integration in labour, agricultural and manufactured goods, energy and oil products, but in the end decisions are still taken at the national level, thus perpetuating an intra-zone segmentation that limits the competitiveness of local companies and delays convergence among countries. But dismantling trade barriers, especially non-tariff ones, would improve efficiency of investments as well as circulation of talents, knowledge and goods. This integration, coupled with efforts in broadening the tax base (an IMF recommendation for the EU also applicable to the WAEMU), could provide local political and economic institutions with greater means to finally stimulate the emergence of a real common industrial setting and diversify their economies in order to improve resilience to idiosyncratic shocks. This seems all the more desirable as the openness of local economies weakens local enterprises, very exposed to international competition, yet still lacking the capacities to produce needed equipment goods. Finally, even if the fixed pegging to the Euro remains an important factor of stability and credibility given the weaknesses of African economies and their persistently strong ties with the Eurozone, the question of abandoning this monetary regime may be raised more seriously in the nearby future, especially in view of increasing trade relations with Asia, and China in particular.