Building Integrated Economies in West Africa

Chapter 2. Macroeconomic Setting and Current Challenges

Alexei Kireyev
Published Date:
April 2016
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Monique Newiak and Christian Josz 

Economic growth in the West African Economic and Monetary Union (WAEMU) has been historically low but has increased recently, driven by structural reforms and economic recovery in the region’s largest countries. With the currency pegged to the euro, inflation in the region had traditionally been low. However, high fiscal deficits have been exerting increasing pressures on the external position. The combined fiscal deficit of the WAEMU has widened recently, largely reflecting rising levels of public investment in infrastructure in several countries. Because of the high import content of this investment, rising fiscal deficits have exerted pressure on the current account deficit, the gross reserves of the Central Bank of West African States (BCEAO), and the net foreign assets of commercial banks. Fiscal consolidation is needed in coming years, consistent with the recently reaffirmed WAEMU convergence criteria. To maintain much-needed infrastructure investment, including public investment, steps to increase tax revenue and control current expenditure will be essential. Should the planned fiscal consolidation in member countries fail to materialize, the BCEAO may need to consider a tighter stance. Prudential standards in the WAEMU are weaker than they are in comparable countries. About a quarter of banks do not meet these prudential standards. Ongoing efforts to strengthen bank supervision and raise prudential standards go in the right direction but will take time and need to be accelerated. Steps to upgrade the regulatory framework and build buffers in the financial system should be accelerated before downside risks materialize.

Macroeconomic Setting

Since 2012, the WAEMU region has experienced strong average growth despite adverse challenges including security issues in some member states. The rebound that started in 2012 as Côte d’Ivoire began its postcrisis recovery is still firming up, helped by rising public investment mainly in infrastructure, as well as private investment. Rising public infrastructure investment also stimulated economic activity. The impact of Ebola on growth, although very important in Guinea, Liberia, and Sierra Leone, was small in WAEMU countries. Consumer prices and underlying inflation have been historically low, and, with the exception of several spikes related to food and fuel prices, approached zero in 2014 (Table 2.1).

Table 2.1WAEMU: Long-Term Economic Trends
2014Population (Millions)Per Capita GDP (U.S. dollars)Exports (Percent of GDP)Current Account (Percent of GDP)Government Revenues/GDP (Percent)Financial Depth (M2/GDP)Main Export Product
Burkina Faso13.2448.911.9−10.312.519.6Cotton
Côte d’lvoire18.2951.
Sources: IMF, International Financial Statistics and World Economic Outlook database; and UN COMTRADE.
Sources: IMF, International Financial Statistics and World Economic Outlook database; and UN COMTRADE.

The consolidated fiscal deficit of the region remains relatively high. The overall budget deficit (including grants) reached 4.6 percent of GDP in 2014, compared with an average of 2.9 percent of GDP during the past decade, owing to rising public investment to address the infrastructure gap, especially in Burkina Faso, Côte d’Ivoire, Mali, and Niger. With tax revenue remaining broadly unchanged at 16 percent of GDP, countries increasingly tapped the regional financial market. In 2014, average Treasury bill rates increased by about ½ percentage point since the beginning of 2014, going from 4.8 to 5.6 percent. Total public debt declined slightly to 38.1 percent of GDP. Fiscal policy and the situation of public finances are the reflection of planned shifts made by governments toward public investment to support growth. The overall budget deficit increase was due to rising public investment to address the infrastructure gap, as transitioning from the primacy of current expenditures to productive investment outlays has been a long overdue endeavor in most of the WAEMU countries. The current momentum, therefore, goes in the right direction; and, coming from very low levels of investment, the rise of the deficit can be seen as temporary.

Monetary policy has been supportive of growth. By keeping a low refinancing rate of 2.5 percent since September 2013, the central bank has helped banks invest part of their high level of liquidity in sovereign bonds on the regional market. Credit to the economy has continued to grow at robust rates and credit to governments at even higher rates. Recently, refinancing operations by the BCEAO have risen sharply and commercial banks’ liquidity position with the central bank has turned from a net creditor to a net debtor position. Commercial banks’ borrowing from the central bank has reached 9 percent of banks’ liabilities, and governments’ borrowing from commercial banks has risen to about 20 percent of commercial banks’ assets. The positive interest rate differential between central bank refinancing and Treasury bills and bonds, and the zero capital requirements for WAEMU government paper, may also have provided an incentive to borrow from the central bank and invest in government paper. The rise of sovereign issuance is a positive development in the region, to be further enhanced as the secondary bond market develops. Governments in the region have regularly and correctly managed the debt stemming from these sovereign issuances and WAEMU authorities do not see major risks in this area. In the meantime, transactions turnover in the interbank market has shrunk.

The external current account deficit has remained well above its historical average. The deterioration of the current account deficit in recent years has been due to an increasing savings-investment gap in both the public and private sectors. The expansion of the private savings-investment gap is mainly driven by a sharp increase in private consumption in Côte d’Ivoire. After some temporary decline, the international reserves of the BCEAO rose slightly in 2014, owing notably to stricter implementation of the obligation to repatriate export receipts, although this was broadly offset by the decline in the net foreign asset positions of commercial banks.

The external position remains sustainable but vulnerabilities have increased. The exchange rate appears broadly in line with fundamentals, but external buffers have not been stable. The BCEAO’s gross international reserves coverage stood at about five months of imports at the end of 2014; commercial banks’ net foreign exchange position has declined and turned negative. The level of gross international reserves is below optimal, based on standard metrics (5–12 months of imports). However, gross international reserves are still significantly higher than the floor that acts as a warning signal under the zone’s monetary arrangement with France (84 percent of narrow money compared with 20 percent).

Outlook and Risks

In the medium term, regional growth should remain strong and fiscal and current account deficits should gradually decline if governments implement their fiscal consolidation plans (Figure 2.1). Growth is projected to exceed 6 percent owing to continued buoyant public and private sector investment and be supported by the weakening of the euro (to which the CFA franc is pegged) and improvement in the terms of trade compared to the IMF’s 2014 Article IV assessment, owing notably to the decline in international oil prices. Meanwhile, inflation is expected to average around 2 percent over the medium term. The overall fiscal deficit should gradually decrease below 3 percent of GDP by 2019 if governments implement their fiscal consolidation plans. Total public debt is projected to stabilize at moderate levels (about 40 percent of GDP). Owing to the decrease in oil prices and fiscal consolidation, the current account deficit (including grants) should gradually improve to about 6 percent of GDP by 2020, with reserve coverage staying above four months of imports. Moreover, the fall in oil prices and the weakening of the CFAF may also lead to a strengthening of the external current account. Overall, these are positive developments that bode well for the future of the region.

Figure 2.1.WAEMU Medium-term Outlook, 2015–2020

Sources: Central Bank of Western African States; IMF African Department database; IMF, World Economic Outlook; and IMF staff estimates and projections.

Note: Three-letter International Organization for Standardization abbreviations used for country names. RHS = right-hand side; WAEMU = West African Economic and Monetary Union.

The outlook for the WAEMU is subject to downside risks. A further decrease in non-oil commodity prices as a result of a slowdown of growth in advanced and emerging market countries would aggregate the negative impact on the external accounts of the recent fall in commodity prices of commodity exporters such as Burkina Faso, Mali, and Niger. Tighter external financing conditions due to the normalization of monetary policy in the United States have increased financing costs in many sub-Saharan Africa frontier markets, including Côte d’Ivoire and Senegal. A further tightening can exacerbate these tensions. The absence of fiscal consolidation and slow structural reform implementation, including reforms to increase public investment efficiency, would reduce growth and worsen the external and fiscal positions of the region. The decline in Ebola infections in the three most affected countries is welcome; a flare-up would pose renewed risks for the region.

Financial Sector Development

Prudential standards in the WAEMU remain low by international standards and their observance is incomplete. The average capital-adequacy ratio of banks is about half that observed in comparable Sub-Saharan African countries, and is lower than the minimum requirement of 8 percent in half of the countries. In addition, the enforcement of prudential standards is loose. Indeed, about 10 percent of banks have negative capital. About one-fourth of banks do not meet the minimum capital requirement. About one-fourth of banks do not comply with the connected lending limit. About half of banks do not respect the relatively high single large-exposure limit, owing partly to the lack of economic diversification. Asset quality is also an issue, as illustrated by the high level of nonperforming loans under less demanding provisioning rules. The substantially negative net foreign assets in banks also cause prudential concerns, as they may signal that banks are exposed to an increasingly high level of foreign exchange risk. Finally, fast-developing regional banking groups, which account for almost 70 percent of WAEMU’s banking sector assets, raise new opportunities but also pose risks, as bank holding companies in WAEMU are not subject to banking regulation or consolidated supervision (Figure 2.2).

Figure 2.2.WAEMU: Financial Stability and Development

WAEMU authorities should enforce existing prudential regulations and raise standards to international best practice. The ongoing efforts to strengthen bank supervision and raise prudential standards go in the right direction but will take time and need to be accelerated. In the interim, it will be important to proceed expeditiously with plans to raise banks’ capital requirements. As the current macroeconomic environment is rather favorable, the steps to upgrade the regulatory framework and build buffers in the financial system should be accelerated before downside risks materialize. It is also important and urgent to subject bank holding companies incorporated in the WAEMU to appropriate banking regulation and consolidated supervision. Deposit insurance and financial stability funds should be made operational as a matter of priority. A single and independent administrative resolution authority should be established to ensure prompt and effective resolution of banks with negative capital.

Authorities are taking steps to upgrade the regulatory framework to international standards and strengthen prudential supervision. The BCEAO has initiated a process aimed at implementing Basel II/III standards and better aligning regulations with Basel principles, including those on consolidated supervision. The WAEMU Banking Commission has put considerable effort into building operational capacity and enhancing banking supervision in the last few years. A deposit insurance fund and a financial stability fund have been established and are expected to start operations soon.

Financial sector development remains one of the main objectives on the WAEMU authorities’ agenda and actions on several fronts are underway. First, the authorities are cognizant that the deepening of the financial sector will help improve the transmission channels of the monetary policy. The BCEAO, in coordination with national authorities, has launched a vast reform program in that regard. This includes the inception of new institutions such as credit bureaus to improve information and boost lending activities, and the development of electronic systems to enhance the interbank market.

Most governments in the region are implementing financial sector development strategies with the view to boost credit to the economy. Key pillars of these strategies include: attracting new banks to address the shallowness of the banking sector and associated weaknesses such as low competition, high borrowing costs, and high concentration of credit; enhancing financial inclusion by lifting bottlenecks and increasing access to banking services; and developing microfinance and mobile banking.

Sovereign bond issuance is also an important instrument for the development of the regional financial market. A specific agency—WAEMU Securities Agency—has been created with the main task of coordinating bond issuance among countries to keep yields under control. Alongside this agency, authorities are stepping up efforts to reap the full benefits of sovereign issuance on the regional market, including licensing primary dealers in government securities to activate the secondary market for government paper.

The administrative and disciplinary measures taken have translated into an improvement in banks’ financial situations. WAEMU authorities are also putting a particular emphasis on the supervision of pan-African banks. As for the whole banking sector, the BCEAO management has liaised with the supervisory bodies of parent banks to coordinate their efforts and harmonize practices for the supervision of pan-African banks.

Structural Transformation and Diversification

Production and export diversification of the region remain low, even by African standards. The structure of the economies has changed little in the past quarter century. The majority of the region’s population is employed in low-productivity agriculture and the secondary sector is underdeveloped. Further structural transformation and diversification of output and exports could yield significant growth dividends. Weaknesses include gaps in infrastructure, education and training, finance, trade networks, functioning factor markets, and supportive regulatory environments. While the evidence is more mixed concerning the success of industry-focused measures, the WAEMU’s agricultural sector warrants special attention, given its large potential for productivity and quality improvements and its high share of employment. The authorities’ regional economic plan, though being only about half covered through committed financing so far, targets key areas such as improvements to governance, access to energy, and the development of regional infrastructure and human resources.

Embarking on a structural transformation agenda and diversifying the economies of the region are at the forefront of the WAEMU authorities’ demand in terms of development programs. The strong growth momentum in the region, paired with macroeconomic stability and a set of favorable global conditions, should be put to profit by member countries to lay the ground for higher potential growth. WAEMU authorities are committed to endeavor in that direction as evidenced by efforts on many fronts.

Most countries in the region have designed development plans with the ambition of transi-tioning to emerging market economies in the coming decades. This is a clear indication of a paradigm shift from fiscal stance-centered plans to ambitious economic transformation plans. Closing the infrastructure gap is one of the first steps of this agenda. In this regard, efforts at the country level are being supplemented by regional programs in the areas of energy and roads. Several corridors have been identified and the project preparation is very advanced for some of them, including the highway between Abidjan-Lagos. Implementation of the second phase of the Regional Economic Program also includes the provision of regional infrastructure and access to energy.

Improving the business climate in other areas, such as enhancing the judicial system, reducing red tape, and accelerating the process of setting up a business, is also being taken on at both the country and regional levels. The WAEMU Commission is also creating the infrastructure to harmonize and disseminate best practices in reforms evaluated in the World Bank’s Doing Business assessment among countries. The WAEMU implements a common industrial policy to supplement national initiatives, with an emphasis on the development of small and medium-sized enterprises. The objective is to create a single market for small and medium-sized enterprises and establish linkages with bigger companies, especially to subcontract public procurements across countries.

WAEMU countries are exporters of agricultural commodities, and intrasector structural transformation is a major agenda item for the region’s policymakers. To this end, adding value to agricultural products through processing is a step in countries’ development plans and a part of the Union’s common industrial policy as well. Likewise, governments’ efforts to attract foreign investment are aimed at enhancing the share of the manufacturing sector in domestic output. This intrasector structural transformation should help transfer resources from the low-productivity agriculture sector toward the manufacturing and service sectors and help broaden employment opportunities for educated youths.

Regional Integration

Promoting regional integration is also a priority for WAEMU authorities, as a way to create a large market of 230 million consumers within the Economic Community of Western African States (ECOWAS). The ECOWAS Common External Tariff became effective in January 2015. Liberalizing trade within the whole region would provide a greater playing field for the private sector to thrive and reap the growth dividends. The implementation of the ECOWAS Common External Tariff offers opportunities for boosting regional trade but also entails risks for regional integration. However, it increases tariff protection for WAEMU countries with the introduction of a new 35 percent tariff band for specific goods, and the possibility to deviate from the common external tariff for 3 percent of countries’ tariff lines for several years, with negligible impact on tax revenue.

Overall, amid the global slowdown and manifold challenges, the WAEMU region has maintained a strong growth momentum. Buoyant public investment, especially in infrastructure that has been held back for too long, stood as one of the key drivers of this performance. Going forward, the opportunity for the region to seize the moment and entrench growth lies in WAEMU authorities’ unwavering commitment to and policies aimed at fostering the structural transformation of their economies. This is the most sustainable way to diversify economies and create the conditions for long-term macroeconomic stability.

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