The CFA franc zone is a currency union linked to the French franc. If viewed as a monetary union alone, it does not appear to be close to an optimal currency area. When viewed as part of a wider franc zone, however, its viability and its benefits become clearer.
Most of the more than 50 countries in Africa are poor, and all have faced enormous challenges during the past decade. Their economic performance and policies have nevertheless been quite diverse. Output per capita in 1989 ranged from less than $100 in Mozambique to more than $5,300 in Libya. The annual inflation rate for the 1980s ranged from negative 1 percent in Chad to 108 percent in Uganda. The percentage of output derived from manufacturing in 1989 ranged from 4 percent in Tanzania to 25 percent in Zimbabwe. Total external debt at the end of 1989 ranged from the equivalent of seven months’ export receipts in Mauritius to 270 months in Somalia. And the average annual rate of change in the exchange rate against the SDR for the 1980s ranged from nearly 135 percent depreciation in Uganda to 1.7 percent appreciation in Rwanda.
This last statistic—the behavior of the exchange rate—may be the most esoteric, but it illustrates a key difference in the way countries have responded to the difficulties of the past decade. The exchange rate plays two very important but conflicting roles in economic policy. It can serve as an anchor for financial stability: If a country can run financial policies so as to be consistent with exchange rates that are stable against key currencies, then that country will gain credibility and will promote confidence in its economy. However, the exchange rate is also an instrument of external adjustment. If a country that has allowed wages and prices to get too high can reduce their real value through exchange rate depreciation, then that country will gain international competitiveness. Because these linkages are complex and uncertain, and because financial stability and competitiveness are both prerequisites for sustainable real economic growth, there is no single “right” approach to exchange rate policy.
Roughly two thirds of all developing countries in the world have chosen to favor stability over flexibility by pegging their exchange rates to a single currency or to a basket of currencies, or (in a few cases) by intervening in exchange markets so as to limit flexibility against a currency. Africa is a microcosm of that choice: 34 out of the 50 countries for which data are available have some sort of pegging arrangement. Two peg to the South African rand, five to the US dollar, 13 to the SDR or other basket, and 14 to the French franc. It is this last phenomenon that is of interest here: Does it make sense today for a large and diverse group of African countries to peg firmly to a single European currency, or is that arrangement a historical accident that could unduly constrain economic policy?
What is the CFA franc zone?
The CFA franc zone is an outgrowth of the economic and financial arrangements under which France administered its colonies. Prior to World War II, French colonies typically maintained their own currencies at parities that were firmly linked to the French franc. After the war, the system was simplified by consolidating the currencies of colonies in the Pacific region into a single currency known as the CFP franc (“le fran des Colonies Françhises du Pacifique”) and all others (most of which were in Africa) into CFA francs (“le franc des Colonies Françaises d’Afrique”). In each case, the currencies were fully convertible into French francs at the fixed parity. Each participating central bank established an “operations account” at the French Treasury, into which it deposited most of its foreign exchange. Convertibility was guaranteed through rules permitting overdrafts on these accounts, if necessary. This system permitted the free mobility of capital throughout the zone, and it encouraged the growth of international trade by instituting common trade and financial policies. These principles continue to govern the CFA franc zone.
The most remarkable feature of the CFA franc zone is that the exchange rate against the French franc has not changed for more than 40 years. There was some initial instability immediately after the war, and the rate was then set at 0.5 CFA franc per French franc. In 1968, France effected a currency reform and issued new francs at the rate of 1 per 100 old francs; the value of the CFA franc was left unchanged, so the exchange rate became 50 CFA francs per new French franc, where it remains as of 1992.
There have been some important institutional changes over the years, however, reflecting the political and economic turbulence that this region of the world has experienced. First, the number of member countries has fluctuated. In the first 30 years, several countries—mostly those that are not contiguous to the others—such as Madagascar and Djibouti—left the zone to establish independent currencies or to adopt the French franc. In the 1980s, however, the trend in membership was reversed, as Mali rejoined in 1984 after an absence of 22 years, and Equatorial Guinea in 1985 became the first member country without colonial (or even close economic) ties to France. Since then, there have been 13 member countries in the zone, forming a contiguous group across the equatorial region of west and central Africa. (The 14th African country pegged to the French franc is the Comoros, which has an independent currency fixed at the same parity as the CFA franc; elsewhere, French Polynesia, New Caledonia, and Wallis and Futuna Islands use the CFP franc, with a different fixed parity.)
A second principal change is that the system has become less dependent on France. The member countries gradually achieved independence in the late 1950s and early 1960s, and major “Africanization” reforms were implemented in 1974. These reforms strengthened the control of the member countries over their central banks, while retaining a participatory role for central bank directors appointed by France. Reflecting these changes, the concept of the CFA franc as a colonial currency was abandoned.
Today there are two separate currencies, both of which are known as the CFA franc, but whose full names have changed. The seven member countries in west Africa—Benin, Burkina Faso, Côte d’Ivoire, Mali, Niger, Senegal, and Togo—use currencies known as the “franc de la Communauté financière d’Afrique.” They have formed a regional association, the West African Monetary Union (WAMU), and have vested authority to conduct monetary policy in a common central bank, the Banque Centrale des Etats de l’Afrique de l’Ouest (BCEAO). The six members in central Africa—Cameroon, the Central African Republic, Chad, the Congo, Equatorial Guinea, and Gabon—use the “franc de la Cooperation financière en Afrique centrale,” and have their own central bank, the Banque des Etats de l’Afrique Centrale (BEAC).
Along with these political and institutional changes has come an increasing degree of economic diversification. From the mid-1960s to the mid-1980s, the portion of the zone’s international trade that was with France dropped from nearly 50 percent to around 30 percent, with other European countries taking up much of the difference. Over the same two decades, the share of food products and agricultural materials in the zone’s exports dropped from 75 percent to less than 50 percent, with petroleum and other mineral products taking up the difference. Nine different products constitute the dominant export commodity for the 13 countries. For seven countries, minerals are the largest export, and for five others, agricultural materials (cotton and timber). For only two countries were food products the dominant export in the mid-1980s: cocoa from Côte d’Ivoire and fish from Senegal. With this diversity have come disparities in per capita output, ranging from less than $200 a year in cotton-producing Chad to more than $3,000 in petroleum-rich Gabon.
There are three basic mechanisms for controlling monetary growth in the CFA franc zone. First, interest is charged on overdrafts in the operations accounts (and interest is paid on credit balances). Second, when the operations account balances fall below specified target levels, the central bank concerned must implement policies restricting credit expansion. These restrictions focus on raising the cost of rediscounting paper with the central bank and restricting access to rediscount facilities; this emphasis on rediscounting reflects both the limited development of domestic financial markets and the absence of bank reserve requirements. In order to implement the credit restriction rules, each central bank’s operations account balance is notionally allocated among the member countries, with a residual allocated to the bank itself. Third, credit from the central banks to the public sector of each country is limited to a maximum of 20 percent of the previous year’s fiscal revenue. These rules do not dictate a strict ceiling on total domestic credit growth, but they do impose a strong measure of financial discipline.
How well does the system work?
The effectiveness of the zone’s arrangements has been subjected to much scrutiny in the past few years, owing to the severe and prolonged deterioration in economic performance since the mid-1980s. The currency has on occasion come under speculative attack in the form of capital flight, in response to rumors of impending devaluation. The countries concerned have responded, most recently in meetings at both ministerial and head-of-state level during the summer of 1992, by seeking to strengthen rather than abandon the arrangements. Notable proposals to emerge from those meetings include plans to establish intergovernmental councils for coordination of monetary, fiscal, and related macroeconomic policies and to promote real (in addition to monetary) integration of the region. Such efforts will succeed in the long run only if the zone itself is a sensible response to economic condition.
One way of analyzing the effectiveness of the CFA franc zone is to ask how well it fits the usual criteria for a successful currency union. These criteria include factors such as the degree of flexibility of wages and prices; the degree of labor mobility; the similarity between countries in the effects from external disturbances; and the degree of intraregional trade. There are positive, aspects on each front, but on none of these economic grounds would the zone appear to be a natural candidate for a common currency area.
Downward flexibility of prices and wages is inherently limited in all parts of the world economy. If prices and wages were highly flexible, the optimum arrangement would be to promote financial stability and the growth of international trade by fixing exchange rates, leaving any required adjustment to individual markets. Studies of CFA franc countries have shown some evidence of downward flexibility of real wages during inflationary periods, but there have been notable examples of failed attempts to cut nominal wages—especially in the public sector—during deflationary periods. In addition, when coffee prices plummeted by half in the mid-1980s, the prices paid to coffee growers held firm throughout the zone.
Labor mobility between countries is significant in certain parts of the region. One recent study estimated that in 1975, 25 percent of employed people in Côte d’Ivoire were foreign nationals, and that labor migration was correlated with economic conditions. This type of migration enables unemployed workers in one country to move to areas where jobs are relatively plentiful; in the absence of such migration, exchange rate changes might provide an alternative means of restoring equilibrium between labor markets. The potential for migration to serve as a flexible response to shifts in economic conditions is limited, however, by the vast distances between cities, the limited transportation network, and restrictive policies in some member countries.
The absence of country-specific shocks would be another consideration that could limit the need for exchange-rate adjustment. Unfortunately, this is one area where the CFA franc zone was hit hard in the 1980s. The major adverse shock in this period was a sharp deterioration in the terms of trade, in the form of a large decline in world market prices of many of the commodities exported by these countries. But the declines were far from uniform. From 1980 to 1990, prices of palm oil, cocoa beans, and uranium fell by 50 percent or more; prices of petroleum, fish meal, phosphate rock, cotton, and beef dropped by 20 percent or less; and timber prices rose slightly. As noted earlier, the structure of exports differs greatly between countries across the zone; these diverse price movements thus have translated into sizable differences in terms-of-trade shifts.
Finally, intraregional trade is quite limited. In contrast, the high degree of intraregional trade in Europe is one of the key arguments cited by advocates of European monetary union: Use of a common currency reduces the cost of making transactions within the union, and the higher the portion of covered trade, the greater the benefit. For example, 57 percent of France’s international trade was with other members of the European Community in 1985–87. In the CFA franc zone, just 7.5 percent of trade was within the region during the same period. This very low portion results from the same factors that limit labor mobility, plus the limited markets for many products in low-income countries.
The zone as a monetary standard
Another perspective on the effectiveness of the zone is whether it makes sense as a monetary standard. An important feature of the CFA franc zone is that it combines the use of a common currency by a group of countries with a firm peg against an outside anchor currency, with the active cooperation of the anchor country. This feature conveys potential benefits, via the establishment of a strong independent central bank, the imposition of fiscal discipline, and the maintenance of currency convertibility—as well as potential costs, via the loss of the exchange rate as an adjustment instrument. On balance, the net benefits on this perspective are rather more favorable.
Perhaps the key to the remarkable persistence of the zone is the benefit from the financial discipline that it imposes and the credibility that it conveys to financial policies. For the 1980s as a whole, all of the CFA franc countries recorded inflation rates that were close to or below France’s inflation rate, in sharp contrast to the highly inflationary experiences of many of the other countries in the region. The unweighted average for inflation in consumer prices in the zone was 4.2 percent (1980–89), compared with 6.5 percent in France. More important, this price stability was achieved at no apparent cost in long-term growth: The mean annual growth in real output was around 2.5 percent, compared with 2 percent in France and somewhat less than 2 percent in neighboring African countries. These simple cross-country comparisons do not imply that growth would have been lower under a more flexible exchange rate regime, but they do indicate that the member countries have done at least as well as their neighbors (all of whom have had somewhat more flexible regimes).
A more direct way of judging the effectiveness of the zone’s hard-currency arrangements is to examine the strength and stability of international competitiveness. Even though inflation has been relatively low, member countries could have lost competitiveness through changes in exchange rates between other countries or through terms-of-trade shocks. In this regard, attention has focused on a few notable cases of appreciation of real effective exchange rates: 36 percent appreciation in Côte d’Ivoire from 1985 to 1988, and the same magnitude in Cameroon from 1982 to 1987. These movements, however, have tended to be reversed over time, and there has been no systematic tendency toward appreciation. Real effective exchange rate indexes are published in the IMF’s International Financial Statistics for five of the CFA franc countries. From 1980 to 1990, only Cameroon showed a net appreciation (just over 10 percent); Togo depreciated by more than 20 percent, Gabon by 10 percent, and Côte d’Ivoire and the Central African Republic by 3 to 4 percent.
These data do not imply an absence of competitive problems. Owing to the deterioration in the terms of trade, the real exchange rate indexes should have declined just to maintain the initial position in external trade, and the magnitude of the external deficit that has resulted is indicative of serious structural imbalances. Like many other developing countries in the 1980s, most members of the zone have experienced rising current account deficits, declining output, depleted net foreign assets, and recourse to rescheduling agreements on external indebtedness. But to the extent that these problems resulted from external traumas rather than from financial mismanagement, the ability of exchange rate flexibility or other shifts in macroeconomic policies to deal with them is inherently limited.
In the final analysis …
Making the case for the CFA franc zone depends on viewing it in broad terms: as a combination of a currency union and a monetary standard. The countries in the zone are economically diverse, and there is relatively little trade among them. They do, however, have very strong trading links with Western Europe. Consequently, the zone has become part of a wide area of currency stability comprising the CFA franc countries, France, and other western European countries. Fully 70 percent of the trade of the CFA franc countries is conducted within this broad zone. By persisting with the currency union in the face of the shocks of the past decade, these countries have traded away the exchange rate as an instrument for external adjustment and in some cases have been forced to resort to protectionism and other price-distorting measures. Overall, however, they have gained a measure of financial stability that has proved elusive elsewhere in the region. In addition, they have maintained and even strengthened their trade and financial linkages with Europe. Whether this trade-off will reap dividends in the long run is one of the key questions facing Africa in the 1990s.
For a more detailed study, see “The CFA Franc Zone: Currency Union and Monetary Standard,” by James M. Boughton, IMF Working Paper (WP/91/133), available from the author.