Monetary union is a potential headache for African traders

Date: 03/09/1998

By Mark Turner

AS EUROPEAN leaders cracked open the champagne after the euro summit this May, west and central Africans wondered if they were the ones who were in for a hangover.

Most of the region's illiterate farmers may not have realised it, but their fortunes were soon to become inextricably linked to power games being played in Brussels and Frankfurt.

As European finance ministers confirmed shortly after the summit, the CFA franc - the local currency in these regions of Africa - to all extents and purposes will become the CFA euro.

This profound change to a currency which has for decades been strictly pegged to the French franc and guaranteed by the French treasury is a potent symbol of the decline of France's traditional role in Africa.

Although Paris, rather than the European Central Bank, will continue to underwrite the currency, 14 countries in Africa now face a monetary future determined by France, Germany, Italy and Spain.

The decision, with all its implications, has reignited the age-old debate in the region over whether exchange rate stability is worth the price of a European-driven currency, especially a strong one which could cost African exporters dear.

Unfortunately for the countries in the western and central African currency unions (WAEMU and CAEMC), which have separate central banks, the jury is still out on that question. Certainly, over the past 20 years, the CFA franc has bequeathed the francophone countries an enviable degree of stability and low inflation compared to their anglophone counterparts and, during the Seventies, appeared to be exactly what the doctor ordered.

But in the 1980s, affected by a growing African malaise, many of the CFA countries (although far from a homogeneous unit) began to feel the strain.

The currency's rigidity and growing overvaluation “contributed to fiscal imbalances and impeded structural changes”, according to Henri-Bernard Solignac Lecompte at the UK Overseas Development Institute.

A lack of intra-regional trade also detracted from the CFA franc's suitability.

From 1986-1993, the franc zone's terms of trade dropped by 5.6&percent; a year, while the CFA's real exchange rate fell by 1.5&percent; a year. In 1994, as global commodity prices continued to decline, the CFA economies could bear it no longer and halved the value of their currency to 100 to the French franc.

The region's policy-makers now face some serious questions. If they are to maintain the currency, which seems likely, they will have to decide whether to keep the current parity (which has, for the past half decade, largely been pegged to the deutschemark anyway), or devalue. They will also have to assess what the euro will mean for the region's dollar-denominated debt. While pegging to the euro is an obvious short-term solution, in the long term it could become increasingly inappropriate.

According to the United Nations Economic Commission for Africa, “the larger the proportion of an economy's trade with one large country, the greater the incentive to peg the local currency to the currency of that country”.

France absorbs 21&percent; of CFA trade, while the EU as a whole accounts for 50&percent;, so by that criterion the euro makes sense.

A recent International Monetary Fund (IMF) working paper drawn up by Michael Hadjmichael and Michel Galy concluded that links to the euro could bring “clear positive gains” for the region, due to improved access to global capital markets, a growing European market for African exports and less price volatility.

But it admitted that while a 'hard euro' could keep inflation down, exporters could suffer, especially faced with Asian and other African competition. An overvalued local currency in west Africa could also damage prospects for inter-regional African trade.

Many other ingredients also determine the desirability of a pegged exchange rate including economic size, openness, diversification, inflation, labour and capital mobility, the prevalence of economic shocks and the credibility of policy-makers.

All of these factors could well change over the next decade, and today's solution is by no means tomorrow's panacea. CFA zone membership is also being reconsidered, with question marks over whether, for example, Ghana should join, especially if it enters a west African free trade zone with the EU.

Furthermore, answering these questions is far from the sole province of French African leaders. It is highly possible that a powerful euro could begin to oust the dollar in day-to-day transactions, especially if the influential British pound joins after 2000.

The World Bank and the IMF may even begin to replace the dollar with the euro in certain regions - a move which would affect all African countries - although not for some time to come. Given the volatility of east and southern African currencies, and especially the recent shocks suffered by the South African rand, other regions may consider a euro-peg, especially if they enter comprehensive free trade agreements with the Union.

These remain hypothetical questions. But given Europe's continued weight in Africa, they will have to be confronted. African leaders would do well to start considering them now.

Aid allocation 1995-2000

Overall allocations - 15,000. Figures in millions of ecu

Conversions of special loans into donations 15

Africa, Pacific, Caribbean (ACP)14,625

Emergency aid/ refugees 160

Overseas countries and territories 200

Overseas countries and territories

European Development Fund (EDF) 165

European Investment Bank (EIB) 35

Africa, Pacific, Caribbean

EDF 12,967

EIB 1,658

ACP - EDF

Subsidies 11,967

Risk capital 1,000

ACP - EDF - Subsidies

Stabex (stabilisation of exports support) 1,800

Sysmin (support for mining) 575

Structural adjustment 1,400

Emergency aid/refugees 260

Interest-rate subsidies370

Regional cooperation 1,300

Other subsidies 6,262

(Source: European Commission)