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Côte d’Ivoire, Ghana, Nigeria… Is West Africa ready for life without the CFA Franc?

By Alain Faujas
Posted on Monday, 30 August 2021 18:12

The transition to eco will have an impact both on the major economic balances and on everyday transactions. PATRICK GELY/SIPA

Bankers, economists, fund managers... Financiers in the West African Economic and Monetary Union (WAEMU) zone are facing the metamorphosis of the CFA franc, with varying degrees of apprehension.

After a further postponement of the launch of the ECOWAS single currency, which was supposed to be launched in 2020, the 15 heads of state and government concerned have set a new date for the transition in 2027. Will it work this time? The question is legitimate, because the deadline for creating the eco is very tight.

The eight member states of WAEMU have been slow to ratify the abandonment of the CFA franc. Nigeria is sulking over this move by Francophone countries. There has been little improvement in convergence between the countries that are candidates for the monetary union. Will the eco rate be fixed or flexible? Will its central bank be truly independent?

Many economic stakeholders are concerned about the vagueness surrounding this monetary revolution. Their analyses covers a range of optimism to acute concern. Representatives of these two extremes are Jean-Luc Konan – CEO of Cofina (a specialist in mesofinance) – and Luc Rigouzzo, co-founder of the private equity firm Amethis.

Pretending to change the currency by saying ‘everything will be fine’ is too simplistic.

Konan, an Ivorian, sees the concern among his partners – who are used to the security of the CFA franc – but he does not share  similar sentiments.

“I worked in Ghana and I found that the flexible exchange rate was perfectly manageable,” he says. “It forces us to anticipate the gains and risks of our operations, to strengthen our skills in managing exchange rate risk. In fact, we leave the comfort of the euro peg every time we do business outside the zone, especially with China or the United States. The exchange rate techniques will not change.”

So this means no major changes; but precautions should still be taken.

“Between the time a [product] is ordered from abroad and the time it is delivered, we will determine the likely final price with the buyer. We will have to use traditional hedging mechanisms, forward purchases and sales, exchange options or currency swaps,” says Konan. In his view, the most important thing is “that this enlargement of [the Ivorian] economic and monetary horizon to 15 countries is done in several stages according to a well-controlled process. The states will have to ensure that the convergence criteria are respected, in this case inflation, budget deficit and public debt”.

Risk of exacerbating social tensions

Not everyone agrees with this approach. Instead, many leaders point to the risk of successive depreciations that a fully flexible exchange rate would bring to the region. “The devaluation of the CFA franc in 1994 benefited agricultural exporters, but not urban consumers. The latter have become the majority in Africa and they depend on imported products,” says Rigouzzo, who points to a possible constant increase in the price of imported goods in local currency and consequently, the permanent erosion of purchasing power of the middle and poor urban classes. This development is likely to exacerbate social tensions.

“Our countries have a trade deficit. This requires large foreign exchange reserves to meet external trade commitments. There is a real danger of triggering terrible inflation in the event of tension on these reserves,” says Youssouf Carius, founder of Pulsar Partners, which manages an investment portfolio of 6.5bn CFA francs (€10m).

The effects go beyond the major macroeconomic balances. “Savers are poorly repaid with rates that often do not exceed 2%. The transition from a fixed exchange rate, where inflation oscillates between 2% and 3%, to a flexible exchange rate regime where it generally reaches between 8% and 10% could seriously penalise the poorest,” says Georges Vivien Houngbonon, economist and administrator at the think-tank L’Afrique des Idées.

For Carius, the lack of debate on the control of price cycles of raw materials for export, the foundation of many countries in the region, is a major source of concern. Another – and directly related – concern is the lack of visibility on the exchange rate regime of the future currency and its implementation schedule. “Since 2003, we still don’t know whether the value of this currency will be guaranteed, like the CFA, or in constant fluctuation like the naira,” he says.

If the new currency depreciates, […] deficit worsens, [and there isn’t] enough foreign investment, some states will have difficulty meeting their debt burden…

“A Malian producer of unprocessed mangoes destined for the Rungis market in France can experience some damage with a flexible exchange rate, because he has less control over his selling price; and if the eco were to fall, he would no longer have a ‘guaranteed’ income over the long term. I’m more in favour of backing the eco with a basket of currencies that would soften currency fluctuations,” says Jean-Marc Savi de Tové, a partner in Adiwale Partners, which manages a €50m  fund targeting SMEs in the WAEMU zone.

What are the practical arrangements?

Beyond the basic exchange rate regime, investors in the region warn that practical modalities of the future system are just as important. “Taking monetary independence and creating a monetary space that brings together Francophones and Anglophones is very good; but, in concrete terms, what will be the basket of currencies to which this currency will be linked if it is flexible? What institutions should be set up to defend it? How to reconcile the divergent interests of oil exporting and importing countries, or within the same country between importers, who favour a strong currency, and exporters who want it to be weak?” says Paul Derreumaux, economist and honorary chairman of Bank of Africa.

“With a flexible eco exchange rate regime, CFA zone countries would experience a currency devaluation compared to the current CFA franc rate, which would increase the value of imports and worsen their trade deficit at least for a while. Importers would suffer and risk fleeing the eco on a massive scale while waiting for the new currency to be definitively installed. It will be necessary to provide them with guarantees to control these risks,” says Houngbonon.

Before the introduction of the eco, states will have to adjust their taxation, facilitate the creation of industries to improve their export capacity and better insert themselves into global value chains …

De Tové, for his part, hopes that “the BCEAO will educate the population more” and that “the governments will say how the ECOWAS countries will converge their economies as well as the accompanying measures planned for the least prepared countries”.

“We need to find a balance between keeping ‘our’ currency at any cost and the economic reality,” he says. “What must come first is that our young people have jobs and our people have enough to eat.” This opinion is similar to that of Derreumaux, who says: “Pretending to change the currency by saying ‘everything will be fine’ is too simplistic”.

“A common currency with Nigeria, which weighs as much as the other 14 members of Ecowas, can only be totally controlled by it. The currency of ECOWAS will be the currency of Nigeria. Nigeria‘s exchange rate policy is governed by oil, which is not the case for the others. The convergence of interests will be difficult to find. On the other hand, if Ghana, Guinea and the WAEMU created a common currency, fixed or not, and completely independent of France; it would make sense because their economies are more convergent and their sizes are relatively similar,” says Jean-Michel Severino, manager of the ethical fund Investisseurs et Partenaires.

Anticipating new monetary situation

In the meantime, financiers in the WAEMU zone must integrate the new monetary situation, however uncertain, into their model; with varying degrees of enthusiasm and apprehension. Carius is still waiting for clarification from the authorities. “As long as I don’t see the system reforming, I won’t reform my activities and my partners won’t prepare themselves for the eco.”

The Ivorian investor does not hide his exasperation. “Monetary migration should not be political, but economic,” says Carius. “When you are in the dark, you anticipate the worst and you remember that some of our Ghanaian colleagues lost 40% of their investments because of the currency fluctuations caused by the oil risks.”

… the evolution of the monetary regime will also have consequences for the budgetary balances of the countries concerned.

Others are taking a more proactive attitude. De Tové, for example, is actively preparing for the arrival of currency risk in his business. “We will not use currency hedging products, because they are too expensive,” he says. “We will focus on the most resilient sectors. We will be even more selective in our investments to compensate for the reduced visibility.”

For Amethis Finance, the priority is to invest in diversified economies with relatively stable currencies, but less in oil-producing countries. “Yes to the eco! But if it is not backed by other major currencies like the Moroccan dirham, its remains entirely flexible. This would increase volatility and risks for people and reduce the attractiveness of West Africa for investors,” he says.

Uncertainties, delays and inconsistencies

Severino is no less critical of a situation that combines uncertainties, delays and inconsistencies. “We are perplexed by the monetary future, which is not conducive to investment decisions,” he says. “No material preparation of the eco seems to be underway, and the situation is confusing between what is happening at the level of WAEMU and ECOWAS.”

This could lead foreign exchange investors to favour investments in export sectors or those that can substitute for imports, which would be negative for the domestic market.

“Investments are not automatically more profitable and therefore numerous with a flexible currency,” says Severino. “A recent example for us is the exit of a Ugandan bank specialising in microfinance, whose profitability, despite its economic performance, was eroded by the depreciation of the shilling,” says the former head of the French Development Agency.

“If the common currency devalues, it will attract foreign investment. On condition that the Central Bank guarantees them capital transfers and convertibility. A trade-off will have to be found between exchange controls to preserve monetary stability and the guarantee that investors will be able to repatriate their funds if necessary,” says Houngbonon.

Need for further reflection

In addition to the impact on the profitability of investments, the evolution of the monetary regime will also have consequences for the budgetary balances of the concerned countries .

“If the new currency depreciates, […] deficit worsens, [and there isn’t] enough foreign investment, some states will have difficulty meeting their debt burden, especially those with a narrow tax base. Before the introduction of the eco, states will have to adjust their taxation, facilitate the creation of industries to improve their export capacity and better insert themselves into global value chains in order to release additional financial capacity,” says Houngbonon.

In fact, the Beninese economist would not be surprised if the timetable for the birth of the eco was modified, as its establishment requires further reflection on these essential subjects. “At the end of this overview, we are tempted to ask what exactly are the authorities doing? If they wish to succeed in their ambitious objective, they must quickly choose the institutions, transparency, caution, restraint and community reflexes that will give their future common currency, the eco, the only foundation that will ensure its long life: confidence.”

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