A Primer on the CFA Franc Zone 8

Richard Bart, and Chorng-Huey Wong
Published Date:
June 1994
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Interest in the two monetary unions in Africa, which have served their member countries well for the last 40 years, has surged recently. This upsurge in interest has been stimulated by the emerging monetary union in Europe and the disintegration of the ruble area in the former Soviet republics.

This paper provides a brief overview of Africa’s monetary unions, addressing three questions. First, what are the institutional arrangements in the West African Monetary Union and the Central African Monetary Area? Second, what are the economic and financial policy implications of these arrangements? Third, what has been the economic performance of the member countries of these unions, particularly in the last decade?

This paper will not examine whether these unions constitute optimum currency areas.1 In a recent study, James M. Boughton concluded that, based on the usual criteria for a successful monetary union, the CFA franc zone would not “appear to be a natural candidate for a common currency area.” However, he pointed out that these countries “have gained a measure of financial stability that has proved elusive elsewhere in the region by trading away the exchange rate as an instrument for external adjustment. Whether this trade-off will reap dividends in the long run is one of the key questions facing Africa in the 1990s.”2

I. Institutional Arrangements

The two unions, often referred to as the CFA franc zone, currently consist of 13 fairly diverse countries.3 The West African Monetary Union comprises Benin, Burkina Faso, Côte d’Ivoire, Mali, Niger, Senegal, and Togo. The Central African Monetary Area includes Cameroon, the Central African Republic, Chad, the Congo, Equatorial Guinea, and Gabon.

Six key elements characterize these unions.4

  • Each union has its own supranational central bank, which in turn has agencies in each member country.

  • Each union has its own currency, designated as the CFA franc. However, within each region the CFA franc denotes a separate currency. For the West African Monetary Union, it is the franc de la Communauté Financière d’Afrique; for the Central African Monetary Area, the franc de la Coopération Financière en Afrique Centrale.

  • The CFA franc for each of the two unions has been pegged since 1948 to the French franc at a fixed exchange rate of CFAF 50 = F 1.

  • The CFA franc is fully convertible into the French franc and, with some exchange restrictions, into other currencies. Convertibility is guaranteed through an agreement with the French Government.5 Under this agreement, the reserves of the countries are pooled together in an “operations account” at the French Treasury, and, in case of need, an overdraft facility is provided at market-related interest rates.

  • Under the monetary arrangements, there is a statutory ceiling-equivalent to 20 percent of the borrowing country’s tax receipts for the previous years—on government borrowing from the banking system for all member countries.

  • Credit to the private sector is limited on an annual basis in member countries, consistent with the national objectives of achieving or maintaining domestic and external financial balances, as well as with the overall objectives of each union.

II. Policy Implications

The implications for economic and financial policymaking for the countries in the two unions derive from the fact that the exchange rate serves as a nominal anchor, having been fixed to the French franc at an unchanged parity since 1948. As a result, these countries must rely on other policy instruments in their adjustment efforts. In particular, fiscal and credit policies are used more intensively than they are in countries where the exchange rate is also available as a policy instrument.6 Price and wage flexibility is likewise important. Although considerable progress has been made in liberalizing the economies of CFA franc countries, wages remain relatively high and recent attempts at reducing public sector pay have met with stiff resistance. Further, producer prices for a number of agricultural products have been maintained at levels above world prices.

Many of the countries in the two unions are currently experiencing serious economic and financial problems that stem from both policy weaknesses and exogenous shocks. Four key reasons for these problems can be singled out.

First, most of these countries pursued highly expansionary fiscal policies in the late 1970s and the 1980s. The zone’s restrictions on government borrowing from the domestic banking system translated into excessive external borrowing and, in a number of cases, into accumulated domestic and external payments arrears.

Second, the monetary authorities attempted to compensate for the expansionary fiscal stance (particularly in the second half of the 1980s), in part by limiting credit to the private sector, effectively crowding out private sector needs.

Third, the extensive public enterprise sector in these countries resorted to heavy bank borrowing. As the financial position of many public enterprises continued to weaken, nonperforming bank loans accumulated and contributed to serious liquidity problems in the banking system.

Fourth, most of the countries in the zone suffered from sharp deteriorations in their terms of trade—starting in the late 1970s and early 1980s—although the intensity and pattern of the deterioration have varied from country to country.

During the 1980s, many of the CFA franc countries implemented adjustment programs supported by IMF resources. However, fiscal policy—the main policy instrument in the adjustment arsenal of these countries—proved unwieldy, and efforts to reduce budgetary imbalances met with only limited success. Although there are differences across countries, the average overall fiscal deficit of the 13 franc zone countries, on a commitment basis and excluding grants, was reduced markedly in the first half of the 1980s to below the average deficit for the other sub-Saharan African countries. It gradually widened in the second half, rising above the average for the other sub-Saharan African countries, reflecting declines in the ratio of government revenue to GDP and an inability to compress current expenditure (Chart 1). These developments reflected not only a further weakening in the terms of trade of the franc zone countries, but also expanding informal sector activities, the financial problems confronting public enterprises, the spillover effects of the banking system’s growing illiquidity, changes in the tax system that at times did not yield the expected revenue, and weaknesses in tax policy and administration. Reducing the ratio of current expenditure to GDP substantially proved difficult, given the large share of the government wage bill in current expenditure and the rising interest obligations on both domestic and external debt. Nonetheless, some progress appears to have been made during 1990–92, when the average deficit for the zone was narrowed to below the average for the other sub-Saharan African countries.

Chart 1.Sub-Saharan African Countries: Central Government Fiscal Deficit

(As percent of GDP)

Source: International Monetary Fund, World Economic Outlook data base.

1 Benin, Burkina Faso, Cameroon, Central African Republic, Chad, Congo, Côte d’Ivoire, Equatorial Guinea, Gabon, Mali, Niger, Senegal, and Togo.

2 Botswana, Burundi, Cape Verde, Comoros, Djibouti, Ethiopia, Ghana, Guinea, Guinea-Bissau, Kenya, Lesotho, Liberia, Madagascar, Malawi, Mauritania, Mauritius, Mozambique, Nigeria, Rwanda, Sao Tome and Principe, Seychelles, Sierra Leone, Somalia, Sudan, Swaziland, Tanzania, Uganda, Zaïre, Zambia, and Zimbabwe.

Some analysts have argued that the fixed exchange rate and lack of exchange restrictions means that excess demand pressures in the monetary unions spills over (primarily into the external sector), affecting inflation less severely. These analysts consider that other African countries using the exchange rate as a policy instrument have experienced higher inflation rates, which have contributed to an expanded nominal tax base and helped reduce real wages and other expenditures. In addition, the appreciation of the nominal effective exchange rate in the second half of the 1980s lowered revenues from international trade transactions. Accordingly, these analysts argue that fiscal adjustment in the CFA franc zone, with its anchored currency, has not been helped along as much as in other African countries through the effects of exchange rate adjustments and inflation. This argument underscores the trade-offs that exist when a currency is anchored over a long period of time. But while the relation between exchange rate and fiscal policy cannot be overemphasized, the fiscal problems confronting these countries stem from the factors previously mentioned and need to be tackled directly.7

In contrast, the record of credit policy has been better. Although credit policy was fairly expansionary until around the mid-1980s, it was brought under control in the second half of the 1980s and further tightened in 1990–92 in an attempt to contain the growing external imbalances (Chart 2). To this end, real interest rates were significantly raised in the second half of the 1980s. Overall, the ratio of domestic credit to GDP has remained well below that for the other sub-Saharan African countries.

Chart 2.Sub-Saharan African Countries: Domestic Credit

(As percent of GDP)

Source: International Monetary Fund, World Economic Outlook data base.

1 Benin, Burkina Faso, Cameroon, Central African Republic, Chad, Congo, Côte d’Ivoire, Equatorial Guinea, Gabon, Mali, Niger, Senegal, and Togo.

2 Botswana, Burundi, Cape Verde, Comoros, Djibouti, Ethiopia, Ghana, Guinea, Guinea-Bissau, Kenya, Lesotho, Liberia, Madagascar, Malawi, Mauritania, Mauritius, Mozambique, Nigeria, Rwanda, Sao Tome and Principe, Seychelles, Sierra Leone, Somalia, Sudan, Swaziland, Tanzania, Uganda, Zaïre, Zambia, and Zimbabwe.

III. Economic Performance

The debate about the West African Monetary Union and the Central African Monetary Area has often centered on whether or not these unions have benefited their member countries. One way of answering this question is by evaluating the countries’ performance in terms of inflation, economic growth, and the balance of payments relative to other sub-Saharan African countries, with the caveat that numerous factors apart from the monetary arrangements affect these variables.


There is a consensus that the countries in the unions have performed well in terms of inflation. During the 1980s, the average annual inflation rate for the zone was about 7 percent, compared with an average of some 25 percent for other sub-Saharan African countries. It is noteworthy that the annual average rate of inflation declined sharply in the zone in the second half of the 1980s, to less than 3 percent, and even further in 1990–92, to less than 1 percent, while inflation picked up substantially in the rest of sub-Saharan Africa, averaging some 30 percent per year during 1985–89 and exceeding 50 percent during 1990–92 (Chart 3).

Chart 3.Sub-Saharan African Countries: Consumer Prices

(Annual percent change)

Source: International Monetary Fund, World Economic Outlook data base.

1 Benin, Burkina Faso, Cameroon, Central African Republic, Chad, Congo, Côte d’Ivoire, Equatorial Guinea, Gabon, Mali, Niger, Senegal, and Togo.

2 Botswana, Burundi, Cape Verde, Comoros, Djibouti, Ethiopia, Ghana, Guinea, Guinea-Bissau, Kenya, Lesotho, Liberia, Madagascar, Malawi, Mauritania, Mauritius, Mozambique, Nigeria, Rwanda, Sao Tome and Principe, Seychelles, Sierra Leone, Somalia, Sudan, Swaziland, Tanzania, Uganda, Zaïre, Zambia, and Zimbabwe.

3 Countries listed in footnote 2 except Zaïre in 1992.

Economic growth

The annual growth rate for the CFA franc countries averaged 2.8 percent during the 1980s, about the same as for other sub-Saharan African countries (Chart 4). But although the growth rate of these countries was nearly twice that of other sub-Saharan African countries in the first half of the 1980s, it started to fall behind substantially in the second half of the decade. Accordingly, while these countries were growing well in the mid-1980s, their more recent experience raises serious questions. Nonetheless, it is interesting to note that the average annual growth rates of the zone and the other sub-Saharan African countries dropped during 1990–92 to 1.2 percent and 1.5 percent, respectively, and thus were close to each other.

Chart 4.Sub-Saharan African Countries: Real GDP

(Annual percent change)

Source: International Monetary Fund, World Economic Outlook data base.

1 Benin, Burkina Faso, Cameroon, Central African Republic, Chad, Congo, Côte d’Ivoire, Equatorial Guinea, Gabon, Mali, Niger, Senegal, and Togo.

2 Botswana, Burundi, Cape Verde, Comoros, Djibouti, Ethiopia, Ghana, Guinea, Guinea-Bissau, Kenya, Lesotho, Liberia, Madagascar, Malawi, Mauritania, Mauritius, Mozambique, Nigeria, Rwanda, Sao Tome and Principe, Seychelles, Sierra Leone, Somalia, Sudan, Swaziland, Tanzania, Uganda, Zaïre, Zambia, and Zimbabwe.

External current account

The combined external current account deficit, excluding official transfers, widened in the latter part of the 1970s, peaking at nearly 20 percent of GDP during 1980–82. It then narrowed briefly in 1983–84 but deteriorated again in the late 1980s. During 1985–89, the zone’s deficit averaged 16.5 percent of GDP, whereas those of other Saharan African countries averaged some 20 percent (Chart 5). In 1990–92, the average deficit in the zone dropped to 15.6 percent of GDP, close to the 16.2 percent deficit of the other sub-Saharan African countries. During 1980–92, the average deficit for the zone as a ratio to GDP remained below that of the rest of the region, but the relative deterioration of the zone’s external position can be gauged by the average deficit, which was about 9 percent of GDP during 1970–74, compared with close to 40 percent for the rest of sub-Saharan Africa. In subsequent years, the external current account position of the zone widened, while that of other sub-Saharan countries narrowed, with the two groups’ average deficits as ratios to GDP virtually converging in 1990–92.

Chart 5.Sub-Saharan African Countries: Current Account Deficit, Excluding Net Official Transfers

(As percent of GDP)

Source: International Monetary Fund, World Economic Outlook data base.

1 Benin, Burkina Faso, Cameroon, Central African Republic, Chad, Congo, Côte d’Ivoire, Equatorial Guinea, Gabon, Mali, Niger, Senegal, and Togo.

2 Botswana, Burundi, Cape Verde, Comoros, Djibouti, Ethiopia, Ghana, Guinea, Guinea-Bissau, Kenya, Lesotho, Liberia, Madagascar, Malawi, Mauritania, Mauritius, Mozambique, Nigeria, Rwanda, Sao Tome and Principe, Seychelles, Sierra Leone, Somalia, Sudan, Swaziland, Tanzania, Uganda, Zaïre, Zambia, and Zimbabwe.

Some analysts have attributed the relative deterioration in the zone’s external position to an erosion of competitiveness. The movements in the index of the real effective exchange rate and the terms of trade are indicators of changes in competitiveness (Chart 6).8 For the zone as a whole, the real effective exchange rate index declined by some 17 percent between 1980 and 1992. In contrast, the index for the other sub-Saharan African countries declined by some 32 percent over the same period. Did the other sub-Saharan African countries improve their competitiveness faster than the CFA franc countries? In fact, the zone’s position may have reflected France’s hard currency policy of the mid-1980s, which translated into a hard CFA franc policy. In addition, the terms of trade of CFA franc zone countries fell on average by close to 25 percent during 1980–92, while those of the other sub-Saharan African countries declined by only some 11 percent. The movements in the indexes and terms of trade should be interpreted with caution, however, and more country-specific studies are needed to determine whether or not there has been a loss of competitiveness.

IV. Conclusion

The overall performance of the countries in the two monetary unions suggests that belonging to the franc zone was definitely beneficial in limiting inflation. In addition, the average growth rate for these countries during 1980–92 was close to that of the other sub-Saharan African countries. These results reflect primarily the relatively restrained monetary policies the unions pursued, the stability of the exchange rate, and the openness of the economies. The CFA zone countries are almost the only ones in Africa that have a virtually fully convertible currency. As a result, internal disequilibria have not resulted in shortages of foreign exchange; the private sector has had access to foreign exchange, and imports have not been constrained by the lack of foreign currency.

Nonetheless, the CFA franc zone faces several challenges today: the general sluggishness of economic activity; the large fiscal deficits in a number of countries, which have caused the accumulation of substantial domestic and external payments arrears; and the relative deterioration in the average external current account position of the zone.

Chart 6.Sub-Saharan African Countries: Terms of Trade and Real and Nominal Effective Exchange Rates


Source: International Monetary Fund, World Economic Outlook data base.

1 Benin, Burkina Faso, Cameroon, Central African Republic, Chad, Congo, Côte d’Ivoire, Equatorial Guinea, Gabon, Mali, Niger, Senegal, and Togo.

2 Botswana, Burundi, Cape Verde, Comoros, Djibouti, Ethiopia, Ghana, Guinea, Guinea-Bissau, Kenya, Lesotho, Liberia, Madagascar, Malawi, Mauritania, Mauritius, Mozambique, Nigeria, Rwanda, Sao Tome and Principe, Seychelles, Sierra Leone, Somalia, Sudan, Swaziland, Tanzania, Uganda, Zaïre, Zambia, and Zimbabwe.

3 Countries listed in footnote 1 except Benin and Equatorial Guinea.

4 Countries listed in footnote 2 except Comoros, Djibouti, Guinea, Guinea-Bissau, Liberia, Sao Tome and Principe, and Somalia.

An important issue for the CFA franc zone today is achieving a sustainable level of economic growth with a viable external position. Can these countries reduce consumption and improve competitiveness with structural reforms and policies that manage domestic demand alone, or will they need the price-switching and money-illusion effects that an exchange rate change can bring about? This issue came to a head recently in a debate in July 1992 among the presidents of the franc zone countries. They came to the conclusion—outlined in their statement of July 31, 1992—that they wanted to maintain the anchor to the French franc and to reinforce their internal adjustment efforts. Whether these internal adjustment efforts will succeed remains to be seen.9


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    MacedoJorgeDraga de.1985. “Collective Pegging to a Single Currency: The West African Monetary Union.”NBER Working Paper No. 1574. Cambridge, Mass.: National Bureau of Economie Research.

    McLenaghanJohnB.SalehM.Nsouli and Klaud-WalterRiechel.1982. “Currency Convertibility in the Economic Community of West African States.”IMF Occasional Paper 13. Washington, D.C.: International Monetary Fund.

    NashashibiKarim and StefaniaBazzoni.1993. “Alternative Exchange Rate Strategies and Fiscal Performance in Sub-Saharan Africa.”IMF Working Paper 93/68Washington, D.C.: International Monetary Fund.

    NsouliSalehM.1981. “Monetary Integration in Developing Countries.”Finance and Development (December) pp.4144.

    TouréMamadou.1991. Statement to seminar on Fiscal Policy Issues in the CFA Franc Zone CountriesMarch6at the International Monetary FundWashington, D.C.


John Odling-Smee

One thing Paul Masson did not emphasize was the debate that took place in Western Europe on the question of whether economic and monetary union would be better for the general level of inflation than a continuation of the existing European monetary system. One side in this debate held that as long as there was scope to adjust exchange rates, as there is in the existing system, some countries would be able to have higher inflation rates. Fixing exchange rates and, ultimately, creating a single currency would remove that scope, and the high-inflation countries would be forced to accept inflation closer to the center, lowering the average inflation rate. The counter view was that the average inflation rate depended on the behavior of the dominant monetary authority. With a single currency, the dominant authority would be the new European central bank, perhaps with some involvement from governments; with the existing European monetary system, this bank was, in essence, the Bundesbank.

It is not possible to resolve this debate a priori, but it is quite possible that involving more authorities in the governance of the new European central bank would result in a somewhat more inflationary outcome, on average, than what would occur if the Bundesbank alone were in charge. This outcome would hold true if the high-inflation countries no longer had high inflation, because with a single currency they would have to lower their inflation rates. A cynic might argue that the only reason why many countries want to have a European central bank rather than the European monetary system is because they want to have a somewhat easier overall inflationary position.

This topic serves as an introductory point and a transition to what I want to say about the ruble area, because one of the more interesting features of developments in the ruble area over the last year has been the way the incentives within the system have created a clear inflationary bias. The absence of monetary coordination has provided an incentive for all countries to try to inflate as quickly as possible, stimulating inflation throughout the whole region. For this reason, the question of finding the monetary arrangement that best-controls inflation or brings about monetary stability in a currency region is something that West Europeans look at from a slightly different point of view in terms of the ruble area.

Another introductory point is again in contrast with what Mr. Masson has been saying. I shall be less concerned with what in some sense ought to be done in the ruble area, in terms of economic objectives, than with what can be done. In terms of the countries, the question is one of political feasibility, since the issue has become rather politicized. In considering economic policy for the region, therefore, it is necessary to be very conscious of the political constraints.

I shall start with a few words about the current situation in the former Soviet Union and then draw attention to the main problems in the ruble area arising from the currency question, discussing possible solutions. The countries of the former Soviet Union have tried to establish working monetary relations between themselves. Although they once used the same currency—the ruble—some of them have already introduced their own currencies. Exactly how to make their system work has become a topic of much debate.

The current situation in the 15 countries of the former Soviet Union has evolved quite quickly since the beginning of 1992, when they were all using the ruble, the currency of the former USSR. During the second half of 1992, first Estonia, then Latvia, and finally Lithuania introduced their own currencies. Estonia pegged the kroon at eight to the Deutsche mark. Latvia and Lithuania floated their currencies—the Latvian ruble and the talonas—which the authorities say are temporary. In November, Ukraine also left the ruble area and introduced its own temporary currency, the karbovanets, which is also floating. The three countries that have temporary currencies—Latvia, Lithuania, and Ukraine—intend to introduce what they regard as their own permanent currencies at some stage in the future, although none has announced a date.1 They do not want to introduce a permanent currency until the financial situation is under control, because they do not want a new currency associated with the very difficult monetary situations they now face, perhaps compromising its prestige. They are therefore waiting for a moment when they can introduce the new currencies successfully, with a reasonable amount of monetary stability. To an economist, this change from a temporary to a permanent currency is a purely technical one, although it has real political significance for the countries involved. Thus, it is possible to talk about these four countries as though they already have their own currencies.

Of the other 11 countries, 2 or 3 have already announced their intention to introduce their own currencies in the relatively near future. Azerbaijan, in particular, has mentioned February 1, 1993,2 and one or two others have said they will take action fairly soon. Other countries have introduced what are called coupons, or surrogate rubles. These trade, one for one, with the ruble and really exist only in cash—not in noncash (i.e., deposit)—form. They were introduced owing to a shortage of cash rubles early in 1992 that has now ended.

Russia continues to issue the ruble and remains the dominant country in the ruble area. Its GDP is over 60 percent of the GDP of the total territory of the former USSR. Now that Ukraine, which had between 15 and 20 percent of total GDP, has left the ruble area, Russia’s share of ruble area GDP is about 75 percent. It controls the only supply of ruble bank notes, since all the printing presses for ruble bank notes are on Russian territory. It also has large balance of payments surpluses with nearly all the other member countries of the ruble area because of the traditional structure of trade. Russia is an exporter of raw materials, especially energy, while the other former republics export manufactured and agricultural goods.

The ruble area as it functions now is defined by the fact that monetary policy among the countries involved is not coordinated. Each central bank extends credit to its government and to commercial banks independently, sets reserve requirements independently, and determines interest rates independently. Although there may be some local control from a government or parliament, there is no effective coordination. The maneuverability of ruble area central banks outside Russia was limited in early 1992 by the Central Bank of Russia’s position as sole issuer of ruble currency, but these central banks were able to finance different rates of credit expansion by borrowing from the Central Bank of Russia, by creating bank reserves, and, in some cases, by issuing coupons or parallel national currencies.

In attempting to isolate themselves from the relatively tight credit policy of the Central Bank of Russia in the early months of 1992, some of these central banks adopted divergent credit and interest rate policies. Some, however, continued to pursue a restrained monetary policy, but once one or two—especially the larger ones—began expanding domestic credit at a rapid rate, others realized that this policy constituted a “free ride.” They could expand domestic credit and create strong inflationary pressures throughout the ruble area as a whole, but these pressures would be shared by all the area’s countries, reducing the risk to individual economies. In fact, it was in the interests of individual countries to expand credit in the absence of any centralized controls or agreements. This was the source of the inflationary bias that I mentioned before. Of course, all the strong inflationary pressures in the former Soviet Union cannot be attributed to the lack of coordination. The policies of Russia itself were very inflationary, and almost certainly they account for the larger part of the overall inflationary pressures in the ruble area.

Until the end of June 1992, Russia automatically financed payments imbalances with the other countries of the former Soviet Union through correspondent accounts the other central banks held with the Central Bank of Russia. At the beginning of the year, Russia was uncertain how the ruble area would operate and did not want to impose too many restrictions on the system. The correspondent account balances were allowed to grow. After the first two or three months, the other countries began to accumulate debts to the Central Bank of Russia—a result of growing payments imbalances.

With effect from the first of July 1992, Russia changed its policy, and, in order to control the growth of interstate credit through these correspondent accounts, the Central Bank of Russia instructed its main branches to centralize all interstate payments through one Moscow office. The Central Bank created a new system of bilateral correspondent accounts, under which payments from another state could not be processed until that state was either running a payment surplus with Russia—not a very common event—or had negotiated a technical credit with Russia to finance a payments deficit (“technical credit” was the name given to explicit credit of a certain amount). In essence, these countries were told that from the first of July they could not borrow from the Central Bank of Russia unless they negotiated an explicit amount. Open-ended credit was stopped. This new system rather quickly led to the blocking of payments from those states that had exhausted their credit limits—as a number of them quite quickly did. This development in turn affected not only payments for trade, but trade itself. One problem was that traders learned their payments had been blocked only after goods had actually been shipped; a Ukrainian exporter, for example, would sell goods to Russia, but the Central Bank of Russia would block the payment, leaving the Russian importer unable to pay the Ukrainian exporter. Huge arrears therefore developed in both directions, but mostly it was Russian enterprises that accumulated arrears with enterprises in other states of the former Soviet Union.

These arrears were not the only consequence of the new system. The aim of the new system was to control credit expansion to the other states, but it did not succeed. Whenever states ran up against their credit ceilings, they applied strong political pressure on Russia to ease the ceilings. In most cases the ceilings were raised, especially after July, when the Central Bank of Russia’s new management showed a greater willingness to extend credit not only to other states but within Russia itself. As a result, the new policy did not restrict the inflationary pressures created by the systemic problem of lack of coordinated monetary policy within the ruble area.

One further consequence of the new arrangements has been that the rubles used in different ruble area states are no longer worth the same amount. Of course, the notes are worth the same amount, because they can be smuggled across borders and exchanged, but the noncash rubles—the deposit money—cannot always be used equivalently. A number of states have introduced restrictions on deposit rubles domestic enterprises earn by exporting to Russia, barring the conversion of Russian deposit rubles into domestic rubles. Other forms of restriction have also grown up. The result is that these deposit rubles are now being exchanged at exchange rates that differ from par, giving rise to a de facto segmentation of the market for deposit rubles within the ruble area.

For example, the primary market for deposit rubles is in Latvia, which, interestingly enough, is outside the ruble area. On November 30, 1992, selling rates quoted by the Bank of Latvia were 0.22 Latvian ruble for each Kazakhstan ruble; 0.24 Latvian ruble for each Ukrainian ruble; 0.35 Latvian ruble for each Belarussian ruble; and 0.4 Latvian ruble for each Russian ruble. These rates are less than one because the Latvian ruble has appreciated: Latvia has been pursuing a tighter monetary policy than other countries in the ruble area since breaking free from the ruble. The differences among those rates are the consequence of the restrictions in the ruble area.

In sum, the lack of a coordinated monetary policy has created a serious inflationary bias in the system and generated issues concerning “free rider” countries. For example, one or two very senior policymakers in some of the smaller ruble area countries have indicated to the IMF their understanding of what the IMF has been saying to them since the beginning of 1992 about the importance of coordinating monetary policy. They have tried very hard to adhere to the rough guidelines that have several times been agreed to about growth in credit. But when some of their bigger neighbors allow credit to grow very rapidly, these policymakers are unable to restrain their politicians from insisting that the smaller countries should follow suit. These countries are clearly under great pressure.

Another point to be made here is that a single currency area can be broken up not by the formal introduction of separate currencies—although obviously that will cause disintegration—but by the imposition of restrictions on payments and capital flows, which generate de facto separate currencies.

In terms of solutions, the situation in late 1992 is clearly very unsatisfactory. The restrictions that countries feel they must introduce in order to try to make the ruble work in some way are seriously damaging trade and payments. All the countries suffer under this arrangement. Clearly a cooperative solution is the right sort of response to this situation. The IMF’s advice is that these countries make a clear choice between two alternatives and act on it: either remain in a single currency area with a common monetary policy or introduce a separate currency.

Under the first option, the countries would have to agree on clearly defined mechanisms for the pursuit of a common monetary policy with only one currency circulating throughout the area. Cash and deposits would need to be interchangeable throughout the area. Credit emission would be determined by a single authority. An alternative system in which separate monetary authorities are responsible for credit emission might be possible, but the authorities would agree on the total amount of credit and its allocation. (This solution was discussed earlier in 1992 but was not then politically feasible.)

In the absence of coordinated but separate monetary policies, it is necessary to have a single monetary policy. There are two ways of organizing such a policy. One is to have an interstate monetary institution of the sort the West Europeans have been discussing and incorporating in the Maastricht Treaty. The second is to have a single central bank, presumably the Central Bank of Russia, coordinate monetary policy for all countries in the ruble area. The choice between the two is a political matter that must be decided by the states themselves. What we can say as economic advisors is that it is essential for the survival of a single currency area that responsibility for the common monetary policy be placed squarely in the hands of a single authority. This authority should be responsible for providing adequate information to all the central banks in the area on important decisions regarding monetary, credit, and exchange rate policy and for harmonizing foreign exchange systems, central bank finance rates, and commercial bank reserve requirements.

Under the second option, in which countries introduce their own currencies, plans would have to be made to ensure that the new currencies were introduced, rubles withdrawn in an orderly way, and disruptions minimized. Governments would need to devote much time and energy to creating the institutions and acquiring the expertise needed to conduct independent monetary and exchange rate policies and manage international reserves. Decisions would have to be made on monetary policy under the new currency, including which exchange rate regime to use. Whatever exchange rate arrangements were adopted, the authorities would need to implement rules and procedures necessary for the conduct of an anti-inflationary monetary policy.

It is absolutely clear that a choice must be made between these two options. Moreover, it is doubtful whether in practice the political situation is such that the first option is feasible. The surrender of sovereignty required to accept a single monetary authority is not likely to be forthcoming in a period when newly independent nations are being built. Most of these countries will find that the only viable solution is to introduce their own currencies. This is politically feasible, though not necessarily economically desirable. I am not drawing on the four considerations that Mr. Masson mentioned at the beginning of his talk—factor mobility, the amount of interdependence between these economies, the degree of congruence, and wage and price flexibility—to decide on optimal currency areas. These issues, of course, could well point in another direction that would lead to a different sort of debate. But in the current situation, political considerations are paramount, and economic policymakers have to take them into account.

Finally, the solution to the current difficulties requires a direct approach to the balance of payments financing problem. What has happened, essentially, is that balance of payments financing from Russia, which has been made available to the other countries through credits on the correspondent accounts, has not led to appropriate policy adjustments in the recipient countries. These countries have opted for financing without adjusting; in fact, the incentive structure is such that they have not been aware of the need for adjustment. Their willingness to adjust would be enhanced if interstate credit arrangements were formalized and separated from payment arrangements, making the balance of payments financing constraint more transparent.

One of the problems with the existing system is that the terms of the credit lines currently provided by the Central Bank of Russia through the correspondent accounts are poorly defined and constantly changing. Interest rates were initially set at the same rate as the Central Bank of Russia’s refinancing rate. They were subsequently reduced to zero. Repayment dates have been set and reset on an ad hoc basis. Credit limits have been increased frequently, in some cases on political grounds. Thus, there is great uncertainty about how much credit is available and how to get it. This situation does not inspire the countries running deficits to try to manage their affairs well, cut down on borrowing to avoid running into credit limits, or adjust appropriately in advance. It is important that procedures be developed for extending credit to meet chronic balance of payments deficits through channels other than the payment systems, so that systems are not overburdened with financing and payments and trade is not arbitrarily disrupted.

Summary of Discussion

Participants agreed that if the states of the former Soviet Union (FSU) were to adopt separate convertible currencies, a payments union would not be necessary because the commercial banks could handle all clearing and settlement operations. A multilateral clearing operation would be required only if some of the currencies were not convertible. However, any clearing mechanism should avoid extending credit beyond a maximum of one week—a much shorter period than was embodied in the European Payments Union (EPU) mechanism.

The discussion then turned to the future of the European Monetary System (EMS). It was pointed out that even if the commitment to existing parities under the EMS was strengthened, the system was not a substitute for full monetary union. To avoid the possibility of speculative attacks under the EMS, the market would have to be convinced that all participating countries were pursuing the same monetary policy. In fact, the market would have to be convinced that one currency was as good as another in terms of existing parities. This weakness suggests that the transition within the EMS from flexible to more fixed rates might not be as smooth as anticipated. However, the EMS was generally perceived as an “in-between” system that has worked reasonably well, unlike the in-between system of the FSU, which has not worked well, especially given the existing constraints.

Participants believed that in recent years the CFA franc countries had suffered a serious loss of competitiveness due to their failure to undertake adequate measures to strengthen the internal adjustment process. At the same time, political pressures had prevented currency devaluations, even though neighboring non-CFA zone countries had devalued. The internal adjustment process had been hindered by institutional rigidities—including strong labor unions that had forced wages up to uncompetitive levels—and an unwillingness to take the necessary fiscal actions. There was also agreement that the magnitude of the problems facing the CFA zone economies had been partially hidden by a buildup of arrears. If these arrears had been paid, the operations account with the French Treasury would have shown a more negative position. The consensus was that the exchange rate would have to be moved unless CFA zone governments substantially strengthened their domestic adjustment policies.

Note: I am grateful to E. A. Calamitsis, A. D. Bida-Kolika, J. Bungay, L. K. Doe, S. Eken, A. Jbili, M. Lazare, K. Nashashibi, P. Youm, and M. de Zamaroczy for useful comments and suggestions, as well as to I. M. Fayad for excellent research assistance. The views expressed are those of the author and do not necessarily reflect those of the IMF staff.

See Nsouli (1981), McLenaghan, Nsouli, and Riechel (1982), and Boughton (1991 and 1992) for discussions of the issues involved.

The Islamic Republic of Comoros is also technically part of the franc zone, but not a member of the two unions. The reference in this paper to the CFA franc zone is confined to the two unions.

Although the transportation of bank notes out of the unions has recently been prohibited, this restriction does not in principle affect the convertibility of the currency through bank transactions.

See Nashashibi and Bazzoni (1993) and Touré (1991) for a discussion of the issues involved in fiscal adjustment in the CFA franc zone.

See Faes (1993) and Godeau (1993) for a discussion of issues relating to the peg of the CFA franc.

Subsequent to the presentation of this paper, the CFA franc in the two monetary unions was devalued, effective January 12, 1994, to CFAF 100 = F 1.

In mid-1993 Latvia and Lithuania introduced permanent national currencies; Ukraine has not yet done so.

In December 1993, the Azerbaijan authorities issued a decree stating that the manat would become the sole national currency January 1, 1994.

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