The CFA : Zone of Fragile Stability in Africa

JAMES M. BOUGHTON

Uganda to 1.7 percent appreciation in microcosm of that choice: 34 out of the 50 he CFA franc zone is a . countries for which data are available have This last statistic—the behavior of the ex- some sort of pegging arrangement. Two peg union linked change rate—may be the most esoteric, but it to the , five to the US dol- to the . If illustrates a key difference in the way coun- lar, 13 to the SDR or other basket, and 14 to T tries have responded to the difficulties of the the French franc. It is this last phenomenon viewed as a monetary past decade. The exchange rate plays two that is of interest here: Does it make sense to- union alone, it does not appear very important but conflicting roles in - day for a large and diverse group of African to be close to an optimal cur- nomic policy. It can serve as an anchor for fi- countries to peg firmly to a single European nancial stability: If a country can run finan- currency, or is that arrangement a historical rency area. When viewed as cial policies so as to be consistent with accident that could unduly constrain eco- part of a wider franc zone, how- exchange rates that are stable against key nomic policy? , then that country will gain credi- ever, its viability and its benefits bility and will promote confidence in its econ- What is the CFA franc zone? become clearer. omy. However, the exchange rate is also an The CFA franc zone is an outgrowth of the instrument of external adjustment. If a coun- economic and financial arrangements under try that has allowed wages and prices to which administered its colonies. Prior Most of the more than 50 countries in Africa get too high can reduce their real value to World War II, French colonies typically are poor, and all have faced enormous chal- through exchange rate depreciation, then that maintained their own currencies at parities lenges during the past decade. Their eco- country will gain international competitive- that were firmly linked to the French franc. nomic performance and policies have never- ness. Because these linkages are complex and After the war, the system was simplified by theless been quite diverse. Output per capita uncertain, and because financial stability and consolidating the currencies of colonies in the in 1989 ranged from less than $100 in competitiveness are both prerequisites for Pacific region into a single currency known as Mozambique to more than $5,300 in Libya. sustainable real economic growth, there is no the CFP franc ("le franc des Colonies The annual inflation rate for the 1980s ranged single "right" approach to exchange rate pol- Francaises du Pacifique") and all others (most from negative 1 percent in to 108 per- icy. of which were in Africa) into CFA ("le in Uganda. The percentage of output de- Roughly two thirds of all developing coun- franc des Colonies Francaises d'Afrique"). In rived from manufacturing in 1989 ranged tries in the world have chosen to favor stabil- each case, the currencies were fully convertible from 4 percent in Tanzania to 25 percent in ity over flexibility by pegging their exchange into French francs at the fixed parity. Each Zimbabwe. Total external debt at the end of rates to a single currency or to a basket of participating established an "op- 1989 ranged from the equivalent of seven currencies, or (in a few cases) by intervening erations account" at the months' export receipts in Mauritius to 270 in exchange markets so as to limit flexibility French Treasury, into months in Somalia. And the average against a currency. Africa is a which it deposited annual rate of change in the ex- most of its foreign change rate against the SDR for the 1980s ranged from nearly 135 percent depreciation in

©International Monetary Fund. Not for Redistribution exchange. Convertibility was guaranteed , , , and —use curren- rules do not dictate a strict ceiling on total do- through rules permitting overdrafts on these cies known as the "franc de la Communaute fi- mestic credit growth, but they do impose a accounts, if necessary. This system permitted nanciere d'Afrique." They have formed a re- strong measure of financial discipline. the free mobility of capital throughout the gional association, the West African zone, and it encouraged the growth of interna- Monetary Union (WAMU), and have vested How well does the system work? tional trade by instituting common trade and authority to conduct monetary policy in a The effectiveness of the zone's arrange- financial policies. These principles continue to common central bank, the Banque Centrale ments has been subjected to much scrutiny in govern the CFA franc zone. des Etats de I'Afrique de 1'Ouest (BCEAO). the past few years, owing to the severe and The most remarkable feature of the CFA The six members in central Africa prolonged deterioration in economic perfor- franc zone is that the exchange rate against —, the , mance since the mid-1980s. The currency has the French franc has not changed for more Chad, the Congo, Equatorial , and on occasion come under speculative attack in than 40 years. There was some initial instabil- —use the "franc de la Cooperation fi- the form of capital flight, in response to ity immediately after the war, and the rate nanciere en Afrique centrale," and have their rumors of impending devaluation. The coun- was then set at 0.5 CFA franc per French own central bank, the Banque des Etats de tries concerned have responded, most recent- franc. In 1968, France effected a currency re- I'Afrique Centrale (BEAC). ly in meetings at both ministerial and head- form and issued new francs at the rate of 1 per Along with these political and institutional of-state level during the summer of 1992, by 100 old francs; the value of the CFA franc was changes has come an increasing degree of eco- seeking to strengthen rather than abandon left unchanged, so the exchange rate became nomic diversification. From the mid-1960s to the arrangements. Notable proposals to 50 CFA francs per new French franc, where it the mid-1980s, the portion of the zone's inter- emerge from those meetings include plans to remains as of 1992. national trade that was with France dropped establish intergovernmental councils for coor- There have been some important institu- from nearly 50 percent to around 30 percent, dination of monetary, fiscal, and related tional changes over the years, however, re- with other European countries taking up macroeconomic policies and to promote real flecting the political and economic turbulence much of the difference. Over the same two (in addition to monetary) integration of the that this region of the world has experienced. decades, the share of food products and agri- region. Such efforts will succeed in the long First, the number of member countries has cultural materials in the zone's exports run only if the zone itself is a sensible fluctuated. In the first 30 years, several dropped from 75 percent to less than 50 per- response to economic condition. countries—mostly those that are not contigu- cent, with petroleum and other mineral prod- One way of analyzing the effectiveness of ous to the others—such as and ucts taking up the difference. Nine different the CFA franc zone is to ask how well it fits —left the zone to establish indepen- products constitute the dominant export com- the usual criteria for a successful currency dent currencies or to adopt the French franc. modity for the 13 countries. For seven coun- union. These criteria include factors such as In the 1980s, however, the trend in member- tries, minerals are the largest export, and for the degree of flexibility of wages and prices; ship was reversed, as Mali rejoined in 1984 af- five others, agricultural materials (cotton and the degree of labor mobility; the similarity ter an absence of 22 years, and Equatorial timber). For only two countries were food between countries in the effects from external Guinea in 1985 became the first member coun- products the dominant export in the mid- disturbances; and the degree of intraregional try without colonial (or even close economic) 1980s: cocoa from Cote d'lvoire and fish from trade. There are positive, aspects on each ties to France. Since then, there have been 13 Senegal. With this diversity have come dis- front, but on none of these economic grounds member countries in the zone, forming a con- parities in per capita output, ranging from would the zone appear to be a natural candi- tiguous group across the equatorial region of less than $200 a year in cotton-producing date for a common currency area. west and central Africa. (The 14th African Chad to more than $3,000 in petroleum-rich country pegged to the French franc is the Gabon. Downward flexibility of prices and wages , which has an independent currency There are three basic mechanisms for con- is inherently limited in all parts of the world fixed at the same parity as the CFA franc; trolling monetary growth in the CFA franc economy. If prices and wages were highly elsewhere, French , , zone. First, interest is charged on overdrafts in flexible, the optimum arrangement would be and and Futuna Islands use the CFP the operations accounts (and interest is paid to promote financial stability and the growth franc, with a different fixed parity.) on credit balances). Second, when the opera- of international trade by fixing exchange A second principal change is that the sys- tions account balances fall below specified tar- rates, leaving any required adjustment to indi- tem has become less dependent on France. get levels, the central bank concerned must im- vidual markets. Studies of CFA franc coun- The member countries gradually achieved in- plement policies restricting credit expansion. tries have shown some evidence of downward dependence in the late 1950s and early 1960s, These restrictions focus on raising the cost of flexibility of real wages during inflationary and major "Africanization" reforms were im- rediscounting paper with the central bank and periods, but there have been notable examples plemented in 1974. These reforms strength- restricting access to rediscount facilities; this of failed attempts to cut nominal wages—es- ened the control of the member countries over emphasis on rediscounting reflects both the pecially in the public sector—during defla- their central banks, while retaining a partici- limited development of domestic financial tionary periods. In addition, when coffee patory role for central bank directors ap- markets and the absence of bank reserve re- prices plummeted by half in the mid-1980s, pointed by France. Reflecting these changes, quirements. In order to implement the credit the prices paid to coffee growers held firm the concept of the CFA franc as a colonial cur- restriction rules, each central bank's opera- throughout the zone. rency was abandoned. tions account balance is notionally allocated Labor mobility between countries is signifi- Today there are two separate currencies, among the member countries, with a residual cant in certain parts of the region. One recent both of which are known as the CFA franc, allocated to the bank itself. Third, credit from study estimated that in 1975, 25 percent of but whose full names have changed. The the central banks to the public sector of each employed people in Cote d'lvoire were foreign seven member countries in west country is limited to a maximum of 20 percent nationals, and that labor migration was corre- Africa—, , Cote d'lvoire, of the previous year's fiscal revenue. These lated with economic conditions. This type of

Finance & Development /December 1992 35

©International Monetary Fund. Not for Redistribution migration enables unemployed workers in one adjustment instrument. On balance, the net From 1980 to 1990, only Cameroon showed a country to move to areas where jobs are rela- benefits on this perspective are rather more net appreciation (just over 10 percent); Togo tively plentiful; in the absence of such migra- favorable. depreciated by more than 20 percent, Gabon tion, exchange rate changes might provide an Perhaps the key to the remarkable persis- by 10 percent, and Cote d'lvoire and the alternative means of restoring equilibrium be- tence of the zone is the benefit from the finan- Central African Republic by 3 to 4 percent. tween labor markets. The potential for migra- cial discipline that it imposes and the credibil- These data do not imply an absence of com- tion to serve as a flexible response to shifts in ity that it conveys to financial policies. For the petitive problems. Owing to the deterioration economic conditions is limited, however, by 1980s as a whole, all of the CFA franc coun- in the terms of trade, the real exchange rate the vast distances between cities, the limited tries recorded inflation rates that were close to indexes should have declined just to maintain transportation network, and restrictive poli- or below France's inflation rate, in sharp con- the initial position in external trade, and the cies in some member countries. trast to the highly inflationary experiences of magnitude of the external deficit that has re- The absence of country-specific shocks many of the other countries in the region. The sulted is indicative of serious structural imbal- would be another consideration that could unweighted average for inflation in consumer ances. Like many other developing countries limit the need for exchange-rate adjustment. prices in the zone was 4.2 percent (1980-89), in the 1980s, most members of the zone have Unfortunately, this is one area where the CFA compared with 6.5 percent in France. More experienced rising current account deficits, franc zone was hit hard in the 1980s. The ma- important, this price stability was achieved at declining output, depleted net foreign assets, jor adverse shock in this period was a sharp no apparent cost in long-term growth: The and recourse to rescheduling agreements on deterioration in the terms of trade, in the form external indebtedness. But to the extent that of a large decline in world market prices of these problems resulted from external trau- many of the commodities exported by these mas rather than from financial mismanage- countries. But the declines were far from uni- James M. Boughton ment, the ability of exchange rate flexibility or form. From 1980 to 1990, prices of palm oil, a US citizen, is the IMF other shifts in macroeconomic policies to deal cocoa beans, and uranium fell by 50 percent Historian in the Secretary's with them is inherently limited. or more; prices of petroleum, fish meal, phos- Department. He was previ- phate rock, cotton, and beef dropped by 20 ously an Advisor in the In the final analysis ... percent or less; and timber prices rose Research Department and Making the case for the CFA franc zone de- slightly. As noted earlier, the structure of ex- holds a PhD from pends on viewing it in broad terms: as a com- ports differs greatly between countries across Duke University. bination of a and a monetary- the zone; these diverse price movements thus standard. The countries in the zone are eco- have translated into sizable differences in nomically diverse, and there is relatively little terms-of-trade shifts. trade among them. They do, however, have Finally, intraregional trade is quite limited. very strong trading links with Western In contrast, the high degree of intraregional Europe. Consequently, the zone has become trade in Europe is one of the key arguments mean annual growth in real output was part of a wide area of currency stability com- cited by advocates of European monetary around 2.5 percent, compared with 2 percent prising the CFA franc countries, France, and union: Use of a common currency reduces the in France and somewhat less than 2 percent in other western European countries. Fully 70 cost of making transactions within the union, neighboring African countries. These simple percent of the trade of the CFA franc countries and the higher the portion of covered trade, cross-country comparisons do not imply that is conducted within this broad zone. By per- the greater the benefit. For example, 57 per- growth would have been lower under a more sisting with the currency union in the face of cent of France's international trade was with flexible , but they do in- the shocks of the past decade, these countries other members of the European Community dicate that the member countries have done at have traded away the exchange rate as an in- in 1985-87. In the CFA franc zone, just 7.5 least as well as their neighbors (all of whom strument for external adjustment and in some percent of trade was within the region during have had somewhat more flexible regimes). cases have been forced to resort to protection- the same period. This very low portion results A more direct way of judging the effective- ism and other price-distorting measures. from the same factors that limit labor mobil- ness of the zone's hard-currency arrange- Overall, however, they have gained a measure ity, plus the limited markets for many prod- ments is to examine the strength and stability of financial stability that has proved elusive ucts in low-income countries. of international competitiveness. Even though elsewhere in the region. In addition, they have maintained and even strengthened their trade The zone as a monetary standard inflation has been relatively low, member countries could have lost competitiveness and financial linkages with Europe. Whether Another perspective on the effectiveness of through changes in exchange rates between this trade-off will reap dividends in the long the zone is whether it makes sense as a mone- other countries or through terms-of-trade run is one of the key questions facing Africa tary standard. An important feature of the shocks. In this regard, attention has focused in the 1990s. CFA franc zone is that it combines the use of on a few notable cases of appreciation of real a common currency by a group of countries effective exchange rates: 36 percent apprecia- with a firm peg against an outside anchor cur- tion in Cote d'lvoire from 1985 to 1988, and rency, with the active cooperation of the an- the same magnitude in Cameroon from 1982 chor country. This feature conveys potential to 1987. These movements, however, have benefits, via the establishment of a strong in- tended to be reversed over time, and there has dependent central bank, the imposition of fis- been no systematic tendency toward apprecia- For a more detailed study, see "The CFA Franc cal discipline, and the maintenance of cur- tion. Real effective exchange rate indexes are Zone: Currency Union and Monetary Standard," by rency convertibility—as well as potential published in the IMF's International Financial James M. Boughton, IMF Working Paper costs, via the loss of the exchange rate as an Statistics for five of the CFA franc countries. (WP/91/133), available from the author.

36 Finance & Development /December 1992

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