I Introduction and Background
- Stéphane Cossé, Johannes Mueller, Jean Le Dem, and Jean Clément
- Published Date:
- June 1996
Since its creation almost 50 years ago, the CFA franc zone has on balance served its members well.1 The common currency, the CFA franc, has been freely convertible into French francs at a fixed rate and has provided an anchor for the economic and financial policies of the member countries. These countries benefited from a long period of remarkably low inflation and—until the mid-1980s—sustained economic growth. The discipline imposed on monetary policy by the arrangements of the zone ensured that appreciation of the currency exchange rate in real effective terms arising from inflationary financing was largely avoided.
After 1985, however, the economic and financial situation of the zone deteriorated as a consequence of two major shocks. First, the zone’s terms of trade deteriorated by about 50 percent during the second half of the 1980s, owing mainly to a sharp drop in world market prices for its major export commodities, principally cocoa, coffee, cotton, and petroleum. Second, the external competitiveness of the zone weakened further as a result of the marked appreciation of the French franc against the currencies of the zone’s other major trading partners. At the same time, the zone was increasingly handicapped by a number of structural and sectoral rigidities, particularly high unit-labor costs.
Despite repeated attempts at internal adjustment, especially to rein in wage costs and restructure the banking systems and public enterprises, per capita income fell steadily, and the economic and financial situation continued to worsen. With governments’ wage expenditure claiming an increasing share of government revenues, and with transfers to public enterprises rising, the public sector financing requirements grew, crowding out the private sector. Very large domestic and external payments arrears were accumulated, aggravating the difficulties of the productive sectors and further weakening the banking systems. Under these circumstances, the zone’s attractiveness to foreign investors diminished substantially—despite the advantage of stable prices and exchange rates—and capital flight increased appreciably.
These difficulties were reflected in a sharp deterioration of economic performance. Before 1985, economic growth in the CFA franc zone was generally much higher and more sustained than in the rest of Africa. Since 1986, however, output has remained virtually flat on average in the CFA franc zone, whereas it has expanded by an average of 2.8 percent a year in the other sub-Saharan African countries (Table 1). The contrast in terms of real per capita income changes is even starker. The overall fiscal and external current account deficits have been much larger in the CFA franc countries, and external debt has increased by more than 40 percentage points relative to GDP, compared with fewer than 30 percentage points on the average in other sub-Saharan African countries.
|(Annual percentage changes)|
|Real GDP growth|
|Real per capita GDP growth|
|(In percent of GDP)|
|Overall fiscal balance|
|External current account balance (including grants)|
Based on consumer price index.
Based on consumer price index.
By the early 1990s, it had become increasingly clear that the adjustment strategy followed until then to address the deterioration in economic conditions in the 14 African member countries of the franc zone needed to be modified.2 Indeed, given the size of the shocks that had buffeted the zone, reliance on measures of internal adjustment alone would have resulted in increased tax rates being imposed on a shrinking tax base and large cuts being effected in current and capital expenditure—particularly in education, health, and infrastructure—thereby jeopardizing the chances for a recovery of output growth.
In developing a more comprehensive adjustment strategy, the CFA franc countries strongly desired not only to preserve the existing regional monetary and exchange arrangements, including the nominal anchor, but also to strengthen monetary cooperation and deepen regional economic integration. The CFA franc countries recognized that a stable common currency rather than 13 separate national currencies increased the moneyness of their currency, reduced the risk element in holding it, and yielded information savings and facilitated transactions among members.
Box 1.CFA Franc Zone: A Profile
The 14 African countries of the franc zone currently consist of two separate groups of sub-Saharan countries and the Islamic Federal Republic of the Comoros. The first group includes the seven members of the West African Economic and Monetary Union (WAEMU)—Benin, Burkina Faso, Côte d’Ivoire, Mali, Niger, Senegal, and Togo. The WAEMU was established on January 10, 1994, and supplemented the WAMU (West African Monetary Union), which has been in existence since November 14, 1973. The WAEMU treaty was ratified and became effective on August 1, 1994. The second group includes the six members of the Central African Economic and Monetary Union (CAEMC)—Cameroon, the Central African Republic (C.A.R.), Chad, the Congo, Equatorial Guinea, and Gabon. The CAEMC was established on March 16, 1994, together with two supporting conventions (CAMU—the Central African Monetary Union—and CAEU—the Central African Economic Union—as well as the CAECU—the Central African Economic and Customs Union). The CAEMC has not yet been ratified.
The two groups and the Comoros maintain separate currencies: the CFA franc, which stands for Communauté Financiere Africaine in the WAEMU and for Coopération Financiere en Afrique Centrale in the CAEMC; and the Comorian franc (CF) for the Comoros. The Banque Centrale des Etats de l’Afrique de l’Ouest (BCEAO) and the Banque des Etats de l’Afrique Centrale (BEAC) are the regional central banks of the WAEMU and CAEMC, respectively. As in the case of the Central Bank of the Comoros, each has an operations account with the French Treasury into which it deposits 65 percent of its foreign exchange holdings. Convertibility of their currencies into French francs through authorized intermediaries is supported by provision for central bank overdrafts on these accounts. The central banks are required by their statutes to maintain a 20 percent foreign exchange cover of their sight liabilities, a limit designed to act in practice as a barrier against open-ended access to the operations accounts that the banks maintain with the French Treasury.
The pooling of official reserves also had a number of advantages. First, an adequate level of reserves held individually by each country would have required a higher level of aggregate reserves than if the union as a whole were to continue to pool reserves, given that the inter-country correlation between shocks is less than perfect. Second, intra-union payment imbalances, which are now automatically covered by internal credits, would become external imbalances that would need to be financed by the use of reserves. Third, there are economies of scale with spreading the overhead costs of transactions (via the merging of financial managements for reserves).
Finally, the common central banks—with their authority to safeguard the foreign exchange cover for currency issue and to administer statutory limits on individual governments’ recourse to central bank credit—have had some measure of independence in determining credit policy, which would be difficult to emulate individually in each of the countries outside the framework of the existing monetary union. The monetary arrangements of the zone have had the advantage of preventing an excessive monetary financing of the fiscal deficits3 and the related risk of inflation, although this has entailed heavy government borrowing from abroad and bank borrowing by public enterprises and, in recent years, the accumulation of domestic and external payments arrears.
Thus, on January 11, 1994, the 14 African member countries of the franc zone decided collectively to broaden their adjustment strategy through a large change in the parity of their currencies, effective January 12, 1994, buttressed by a coherent set of macroeconomic and structural policies tailored to the circumstances of each country. The CFA franc countries also decided to strengthen their efforts toward economic integration.
The CFA franc was devalued by 50 percent in foreign currency terms, from CFAF 50 to CFAF 100 per French franc, and the Comorian franc was devalued by 33 percent, from CF 50 to CF 75 per French franc. The size of the parity change was determined on the basis of several indicators of the extent of the overvaluation of the CFA franc and the Comorian franc, including the evolution of the real effective exchange rate, the magnitude of the deterioration in the terms of trade since the mid-1980s, and the need to restore domestic and external equilibrium in the medium term.
This paper reviews developments in the CFA franc countries in the aftermath of the January 1994 CFA franc devaluation. After a brief summary of the new adjustment strategy (Section II), it describes the progress made and the difficulties encountered during 1994 and early 1995 in implementing the programs supported by use of Fund resources (Section III); and discusses the challenges that lie ahead in securing the conditions for the achievement of sustainable growth and financial viability over the medium term, taking into account the regional dimension of policies (Section IV). Preliminary conclusions are presented in Section V. There are five annexes to this paper: Annex I contains statistical information; Annex II provides a brief description of the ongoing regional integration efforts; Annex III reports on developments in monetary policy; Annex IV summarizes Fund technical assistance; and Annex V describes World Bank Group technical assistance.
See Box 1 for a profile of the CFA franc zone.
While statistical information on the Comoros is provided in Annex I, this paper does not discuss the case of the Comoros, which is a member of the franc zone but not a member of a monetary union.
The statutory ceiling on outstanding government borrowing from the common central banks is equivalent to 20 percent of recorded government revenue.