VI Currency Convertibility, Monetary Integration, and Intraregional Trade: Views in Member Countries of the Community
- Saleh Nsouli, John McLenaghan, and Klaus-Walter Riechel
- Published Date:
- August 1982
A primary objective of the Fund’s mission to selected member countries of the Community and the related Fund questionnaire forwarded to all countries in the Community was to elicit views on the prospects for attaining convertibility among the currencies of the member countries in the short to medium term and on the methods for achieving it. Related to these central issues were questions pertaining to the significance of inconvertibility for intraregional trade and to the prospects for adapting existing currency arrangements, together with longer-term problems, such as the effects of convertibility on investment flows. This chapter summarizes these views. In addressing these questions, representatives of the individual member countries emphasized that their responses were related only to the technical issues involved and were not intended to prejudge the important policy matters that would need to be dealt with at a later stage.
Convertibility and Intraregional Trade
Both the discussions with the authorities of the Community members and the Fund questionnaire dwelt at some length on the major factors behind the low level of intra-Community trade, focusing particularly on the relationship between currency convertibility and the growth of trade within the Community. In this regard, they were intended not so much to evaluate the intrinsic features of those factors identified as obstacles to the growth of intra-Community trade but rather to determine the relative importance of these obstacles, so as to assess the significance of currency convertibility as one of a number of factors affecting the growth of trade. Although several other studies had addressed this question in detail,19 the responses received by the mission represented an actual assessment of the relative weights attached by country authorities and other officials to the determinants of trade within the region and to the impediments to an increase in that trade.
The dominant factor inhibiting the expansion of trade within the region was seen to be the current production profiles in the member countries of the Community. Underpinning those profiles are factors of long-term economic significance. Viewed historically, the present production patterns and capacities in these countries represent the outcome of investment flows and trends in the exploitation of resources. Trade flows have largely consisted, on the export side, of raw materials and other primary products destined for the markets of the industrial countries (in which the former metropolitan countries have continued to play an important, though declining, role) and, on the import side, finished investment and consumer goods originating largely in the industrial countries. In many respects, the production profiles in many member countries have quite competitive characteristics, particularly in regard to agricultural production. Although some trade within the region does take place in agricultural commodities, usually in order to accommodate seasonal demand/supply variations, a significant expansion of trade in these commodities within the Community was viewed as unlikely in the foreseeable future. As for manufacturing production, the emphasis in most member countries has been, almost wholly, on the development and enhancement of import substitution industries. Thus, trade in manufactured goods of local origin among member countries has been low, with little prospect of any major increase in the short term, since production capacity in individual member countries is generally insufficient to meet domestic demand. Any appreciable improvement in the prospects for growth of intra-Community trade was therefore seen to be dependent on a Community-wide reorientation of investment flows in order to exploit production potential. This would need to take into account the different levels of economic development among member countries, with important implications for the structure and location of investment.
The dominance of trade between the member countries of the Community and the developed countries in the total trade of the Community depends on efficient transportation and communications systems between these two groups of countries. By contrast, transportation and communication facilities within the Community have been largely neglected until recently. There was general agreement in the member countries that transportation facilities in the region were inadequate for handling any sizable increase in the volume of trade. Special mention was made of such problems in the member countries that are landlocked. Poor communications were viewed as another major impediment to intra-Community trade. Channels of communication between individual member countries and Europe and the United States were considered to be fully capable of handling the needs of modern-day commerce, whereas between neighboring capitals of member countries, in some cases only a hundred or so miles apart, poor communication often caused inordinately long delays in completing transactions. Although the transportation and communication systems in the region had improved over the last decade, inadequate facilities remained serious obstacles to any broad-based attempt to increase intra-Community trade.
Important steps taken at the Community level to establish a program of tariff harmonization among member countries, with the aim of eventual elimination of customs tariffs within the region by 1989, have enhanced prospects for intraregional trade. On the other hand, quantitative import restrictions of a global nature are in force in several member countries, partly reflecting the policy response by the authorities to deep-seated balance of payments problems. In addition to customs tariffs, which have as a primary purpose the generation of budgetary revenues, several countries are applying other cost restrictions on imports, such as import deposit schemes and import surcharges. In general, these trade restrictions were considered by the authorities in most member countries to have only a minor influence on intraregional trade, and little immediate effect on intra-Community trade was expected from their removal. On the export side, quantitative restrictions are usually applied for only a limited time because of supply shortages, mostly relating to commodities traded to non-Community countries.
The inconvertibility of the currencies of a number of the member countries of the Community is most evident in the range and depth of exchange restrictions applied in most of these countries. As was observed in Chapter III, some member countries maintain exchange systems that are free or relatively free of restrictions, while others continue to apply severe restrictions on payments and transfers for current international transactions. These restrictions are symptomatic of sustained balance of payments pressures in these countries. Almost all member countries maintain controls and restrictions on capital outflows while following policies that encourage capital inflows. None of them maintain discriminatory exchange restrictions. In general, exchange restrictions were not considered important in explaining the low level of intraregional trade. Indeed, a significant number of the exchange restrictions were related to payments and transfers for invisibles rather than to trade transactions, although it was noted that several countries were in arrears on their import payments. Although the dismantling of exchange restrictions was viewed as a step that would have a positive effect on monetary cooperation, the present circumstances of many countries were considered unlikely to foster any early initiatives toward a broad-based reduction of these restrictions. Such moves could only be made in conjunction with steps for a substantive adjustment effort to overcome balance of payments problems. This did not, however, rule out the possibility of beginning to harmonize exchange controls within the region with a view to rationalizing the restrictive system.
Approaches to Monetary Integration
Chapter II established a framework for a graduated approach to monetary integration to culminate in the eventual attainment of a complete monetary union, by which the countries belonging to the union would share a common currency and maintain a single exchange arrangement. This scenario was accompanied by a review of the preconditions that would be needed in order to move to the first phase of monetary integration. Three discrete stages on the path toward monetary integration were identified. The first stage, under which the participating countries would enter into a convertibility agreement, would enable the countries to maintain their existing currencies and exchange arrangements if they agreed to accept the currencies of other participating countries for all transactions within the region and to convert these currencies at exchange rates determined by cross rates vis-à-vis the reference currency or currencies in international markets. A more advanced form of monetary integration would take place under a partial monetary union in which, consistent with the terms of the convertibility agreement, exchange rates for currencies of the participating countries were, in principle and in fact, irrevocably fixed. The ultimate form of monetary integration was defined as a full monetary union, which would be established when a single currency was issued for all members by a central monetary authority.
The representatives of member countries of the Community, in their responses to the Fund questionnaire and in discussions with the Fund mission, unanimously ruled out the full monetary union as a viable option for the Community in the short term. The achievement of a monetary union in this form was regarded as the “ultimate objective” of monetary integration and thus as a long-term goal to be achieved through a step-by-step process of monetary cooperation. There was no attempt to predict the time frame within which monetary union could be achieved, but it was seen as consistent with the eventual attainment of complete economic integration within the Community. The probable difficulties in the move toward monetary union were recognized as formidable. In this regard, special reference was made to the cautious, long-term approach to monetary integration of the member countries of the European Community. Furthermore, it was recognized that an important cost of monetary integration, involving the harmonization of fiscal and monetary policies, was the surrender of autonomy in economic policy. This cost, it was noted, had to be weighed against the advantages to be gained from a monetary union, both for individual countries and for the Community as a whole.
The arguments pertaining to a full monetary union were applied, with much the same emphasis, to the possibilities for achieving a partial monetary union. It was felt that, because of the substantial differences in the present economic and financial circumstances of member countries of the Community, as reflected particularly in the unrealistic rates of exchange and inadequate foreign exchange reserves, the establishment of a system of fixed exchange rates among the currencies of member countries would create severe pressures that would soon undermine the fixed parity relationships. At the same time, it was recognized in most of the member countries that a partial monetary union, if introduced at an appropriate time, would constitute an important intermediate step toward full monetary integration. Such a system could not be made operable in the near term without action to limit severely the range of transactions to be covered by such an exchange regime. Although the exchange arrangement under such a regime would in substance be close to that of a full monetary union, it would still permit a limited degree of freedom for policymaking since each country would retain its own currency. Inherent in such a system was the possibility that, if severe pressures arose, the exchange rate could be changed or, as a more serious step, that a country could withdraw from the union.
In view of the probable difficulties in implementing either a full or a partial monetary union, the form of monetary integration viewed as most likely to gain the early support of the member countries of the Community was a convertibility agreement along the lines outlined in Chapter II. Because such an agreement, in principle, could operate within the existing exchange arrangements of member countries, which would retain their national currencies, complete harmonization of policies for the purposes of maintaining the viability of the monetary union would not be necessary. To be effective, the agreement would require elimination of exchange controls and restrictions within the region and relative uniformity of exchange controls and restrictions vis-à-vis third countries. Thus, a convertibility agreement would represent an early stage of monetary cooperation under which participating countries, while recognizing the need to take into account the requirements of other countries and of the Community as a whole, would be able to establish and retain national economic priorities and policies. However, it was generally agreed that the present large payments imbalances in a number of member countries must be eliminated before such a convertibility agreement could be considered feasible.
Preconditions for Convertibility
In accordance with the definition of “limited convertibility” given in Chapter II—i.e., full convertibility of currencies within the region—it was noted that certain preconditions must be met in order to make a convertibility agreement operationally viable. These preconditions would have, as a primary objective, the achievement by individual member countries of a reasonable degree of balance in the external sector. Recognizing that several member countries presently were experiencing severe balance of payments problems, an adjustment program employing the main economic policy instruments would need to be implemented, with sufficient time to achieve the desired results, before a convertibility agreement could be viewed as a practicable step.
Under the present circumstances of the member countries of the Community, another important factor pertained to preconditions for convertibility. It was recognized that, to be viable, limited convertibility would require a uniform degree of convertibility by member countries vis-à-vis the rest of the world. The absence of such uniformity would result in leakages, by which the country or countries with the least restrictive exchange system would essentially act as a conduit for commodity and capital flows from countries with relatively weak balance of payments positions to those with stronger positions. Limited convertibility, therefore, had to be attained in a way that permitted countries with few exchange restrictions to retain their existing exchange systems, while those with more stringent restrictive systems would need to take steps to achieve the same degree of liberalization. This assumed, implicitly, that all countries would move toward reducing reliance on exchange restrictions. Thus, in the present situation, in which certain member countries maintained exchange systems essentially free of restrictions on payments and transfers for current international transactions, in accordance wth the obligations of Article VIII of the Fund’s Articles of Agreement, other member countries would need to take action to reach the same degree of liberalization. In the context of payments and transfers for current international transactions, given the fact that the currency of one member country is fully convertible, all member countries would therefore need to achieve not only “limited convertibility,” as defined, but also convertibility with respect to the currencies of all countries outside the Community. Under these conditions, a convertibility agreement obviously implied a much greater effort in terms of adjustment policies than one in which uniformity in the exchange system within the Community involved the maintenance of a relatively high degree of exchange restrictions vis-à-vis the rest of the world.
Convertibility and Investment Flows
Although a great deal of emphasis has been placed on prospects for the expansion of trade within the Community upon the attainment of currency convertibility within the region, the importance of convertibility for capital flows and for the generation of investment was also recognized. At present, investment flows between the member countries are insignificant. Currency convertibility within the region, as an important step of the movement toward economic integration, would have an ensuing benefit in the enhancement of mobility of both capital and labor. The extended market for goods and services that could be expected to follow currency convertibility should induce inflows of private capital from nonmember countries of the Community and should also generate capital flows within the region. However, certain requirements had to be met before these benefits could be realized. They included the prior harmonization, or even uniformity, of investment codes and regulations which, if left in their present divergent state, would tend to misdirect investment flows. Investors would need to be granted government guarantees against political and exchange risks. Certain drawbacks that could arise from the free movement of capital were also noted in several countries. Thus, the need to avoid a concentration of investment in countries currently benefiting from high rates of return on capital was given high priority. This problem was relevant with respect to inflows of capital from outside the region as well as to capital movements within the Community itself. It was also felt that capital flows deriving from currency convertibility should not include investment in speculative activities or in sectors that did not form an integral part of the development strategies of the individual member countries. Finally, a strong effort would be required to guard against the encouragement of investment that would penalize the landlocked countries within the Community. It was suggested that, in order to meet some of these problems, a “compensation fund” was needed to ensure that the benefits from investment in Community-wide activities were distributed equitably among members.
With these reservations in mind, a qualified approach was taken to short-term prospects for capital flows and investment within the region. The present weak balance of payments of a number of member countries of the Community was seen as a negative factor in any early movement to enhance such flows. Indeed, the possibility of achieving stable exchange rates and the related conditions necessary to facilitate capital flows was viewed as unlikely in the short term, with some officials taking an even more pessimistic view that in the present situation there was more possibility of an increase in restrictive practices than of liberalization of them. In summary, it was contended that the necessary conditions for convertibility, in order to promote balanced capital flows and investment within the region, included an adequate level of foreign exchange reserves, a sustained period of relative equilibrium in the balance of payments, and a satisfactory rate of inflation, together with political stability. However, circumstances within the region at present made it unlikely that these conditions would be attained in the near future. Nevertheless, the issue was considered to be of such importance that it should be the object of a separate, detailed study.
Role of the West African Clearing House
It was generally agreed that the West African Clearing House had an important role in facilitating financial transactions in the region and that any increase in its effectiveness would be a further step in increasing monetary cooperation in the region and in moving toward eventual convertibility. An increase in effectiveness could come from a strengthening of the institutional arrangements of the Clearing House as well as from new initiatives to widen its sphere of influence.
The primary concern with the operation of the Clearing House in most countries was the problem of delays in settlements at the level of transactions between commercial and central banks as well as between the central banks and the Clearing House itself. A number of suggestions were made for strengthening administrative procedures for settlements, but these are outside the scope of this paper. Other suggestions to increase the effectiveness of the Clearing House included an expansion of the one-month settlement period and a reappraisal of the credit limits available to individual countries, which in the view of some participants in the Clearing House are too low. It was also noted that oil imports from Nigeria by member countries of the Community were not channeled through the Clearing House. This arrangement works to the benefit of importing countries, since at present each country maintains a bilateral arrangement with Nigeria for the settlement of oil import bills, yielding more advantageous settlement terms than would be possible if such transactions passed through the clearing accounts of the Clearing House. For this reason, as a means of increasing the coverage of transactions channeled through the Clearing House, it was suggested that special arrangements should be introduced to include oil transactions within the clearing mechanism. There was also qualified support for proposals to make obligatory the channeling of intra-Community transactions through the Clearing House. Although some reservations were expressed with regard to these proposals, a gradual move toward the compulsory use of the Clearing House was seen as a positive step that would be fully consistent with the movement toward convertibility.
There was considerable interest in possible benefits from making the West African Unit of Account (WAUA) more than a mere accounting unit. It was pointed out that the Clearing House itself is presently studying proposals for the issuance of travelers checks, denominated in WAUA, on behalf of its own members. In addition, suggestions have been made for arrangements among the central banks of the member countries of the Community for the repatriation of currency notes up to a certain limit. Other measures considered likely to lead to an improvement in the operation of the Clearing House include the establishment of a wider network of correspondent relationships between commercial banks in the region and more satisfactory arrangements to apply without delay important changes in exchange rates of the currencies of member countries of the Community vis-à-vis the WAUA. In this connection, agreement had already been reached on more flexible arrangements to apply exchange rate changes to transactions passing through the clearing mechanism. While continuing to provide for adjustments of intraregional exchange rates twice monthly, the Clearing House was now applying new exchange rates immediately whenever exchange rate action by an individual member country during the two-week period resulted in a substantially different rate vis-à-vis the reference or intervention currency. This change should avoid the rigidities of the previous system, which tended to penalize importing countries. However, it was noted that an element of exchange risk remained. Finally, some authorities considered that, in order to operate effectively, the Clearing House should have the support of a “reserve fund,” which would provide credit support on a regular basis for the conduct of its operations. Although some contended that the Clearing House had been established to operate as a clearing mechanism and not as a credit institution, others felt that its operations could prove of more benefit to members if a certain amount of credit could be made available to assist deficit countries with their balance of payments problems. The supporters of the latter approach believed that these arrangements were not inconsistent with the basic purposes of the Clearing House.
See, for example, Monetary and Financial Obstacles to Trade Expansion and Possible Improvements in Payment Relations, a report prepared in March 1979 by the United Nations Conference on Trade and Development (UNCTAD) in collaboration with the Economic Commission for Africa.