Vera Songwe: Euro slump makes the CFA zone a victim of ‘imported inflation’

For the first time since 2002, the euro and the US dollar have been close to parity. In the space of a year, the European currency has lost 13.2% of its value against the greenback. This has dragged down the CFA franc used in West and Central Africa, which lost 11.46% of its value against the dollar between 31 December 2021 and 11 July, its lowest level for twenty years.

This historic depreciation is accompanied by high inflation, a possible recession, and a climate of uncertainty regarding the supply of certain products. This situation is worrying the markets and investors, not only in Europe, but also in Africa. As a reminder, the CFA franc, whose convertibility is guaranteed by the French Treasury, is pegged to the euro at a fixed parity (1 euro = 655.957 CFA francs).

The domino effect

The CFA franc follows the same variations as the euro against the dollar, and indirectly depends on the monetary policy of the European Central Bank (ECB). For the time being, the increase announced by the ECB in its key rates (0.5 points) on 21 July, one month after the increase (0.75 points) in the key rates of the US Federal Reserve (FED), has not had any impact on this fall in the value of the euro against the dollar.

This depreciation of the CFA franc may give a certain comparative advantage to exporting countries, but overall its consequences will be harmful in Africa. A depreciated CFA franc means a drop in the purchasing power of the economies concerned: everything that comes from dollarised economies will be more expensive (medicines, computer equipment, refined oil products such as paraffin, etc.)

“This is imported inflation,” says Vera Songwe, UN Under-Secretary-General and Executive Secretary of the Economic Commission for Africa (ECA).

With the combined effect of higher world market prices and increased freight costs, this depreciation is likely to further fuel the inflationary spiral in Africa and widen trade deficits.

Increasing exports

Whether European or African, the big winners of this currency parity seem to be the exporters. Products initially priced in euros, and by extension in CFA francs, are now cheaper for US wallets in dollars.

Africa, which mainly exports minerals and agricultural products (cotton, cocoa, cashew nuts, bananas, etc.), has a better chance of gaining a foothold on the international market thanks to its price competitiveness, which could boost revenues and thus increase the resources of the countries concerned. This is a godsend for oil and gas producing countries such as Congo, Gabon, Niger, Cameroon and soon Senegal, which are already reaping significant benefits from the surge in crude oil prices ($104 per barrel of Brent).

However, Songwe was keen to qualify this analysis. “Even if these countries sell raw materials at higher prices or in greater quantities, they will not necessarily benefit, since they import refined oil and other processed products, which they will de facto pay more for than before. Moreover, the additional revenue will not automatically be a gain, as it will have to be used to pay off a growing debt,” she explained.

Increased debt service

This significant depreciation of the currency used in West and Central Africa will automatically increase the cost of servicing dollar-denominated debt. “To repay the debt issued in dollars, it will be necessary to mobilise a larger amount of CFA francs,” says Songwe. Thus, the current account balances of the countries in the region will be hit.

In order to be able to meet repayments, many African countries may give in to temptations such as turning to donors, requesting moratoriums, or taking on debt from private creditors. For ECA’s chief economist, the most logical solution is to issue more special drawing rights (SDRs) for Africa. “SDRs are not debt, they are a well thought-out and necessary currency creation,” she said.