Back Matter

Back Matter

Catherine Pattillo, and Paul Masson
Published Date:
February 2001
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    Appendix I Economic Policies in Non-WAEMU Countries


    Nigeria has had generally weak economic performance resulting from economic mismanagement, fiscal indiscipline, unproductive public spending, persistent exchange rate overvaluation, and over regulation. Structural reforms during 1986–90 resulted in substantial growth, but policy weakenings and reversals afterward brought about stagflation. Nigerians became convinced that structural adjustment was responsible for all their country’s economic ills, including the depreciating naira, high and variable inflation, and the collapse of domestic industry (Moser and others, 1997). In 1994 the government reimposed interest rate controls and eliminated the free market for foreign exchange, pegging the currency at an overvalued rate. Partial deregulation began again in 1995, with the liberalization of exchange rate controls, restoration of foreign exchange bureaus, and introduction of a dual exchange rate regime, with an administratively determined official rate and a flexible auction rate. Relatively prudent fiscal and monetary policies during 1996–97 together with high oil prices helped reduce inflation from a peak of 77 percent in 1994 to 10 percent in 1997, and increase average real GDP growth to 4 percent. Economic growth, however, continued to be hampered by fuel, power, and fertilizer shortages, and political uncertainties.

    By early 1998, Nigeria had a multiple exchange rate system: an artificially overvalued official rate for government and oil transactions, an “autonomous foreign exchange market” (AFEM) with a rate administratively determined in a managed float (with reference to the interbank and parallel rate, and supported by net infusions of foreign exchange from oil exports), plus foreign exchange bureaus and an active parallel market. Access to foreign exchange for current account transactions was quite liberal, although some restrictions remained.

    The Abubakhar administration abolished the official exchange rate in 1998. Some initial progress in controlling government spending was made in the face of sharp drops in petroleum revenues, but the budget deficit increased to over 8 percent in the first half of 1999, financed by central bank credit. Real change began in June 1999, as democratically elected President Olusegun Obasanjo took office, taking immediate actions to combat corruption and build public confidence. Inflation fell and the exchange rate stabilized. There have been no signs of a sustained revival in real GDP growth, however. The abolition of the AFEM and the enhancement of the interbank (or IFEM) market has led to a more flexible, market-determined exchange rate for the naira. In the program for 2000/01 supported by an IMF Stand-By Arrangement, the Nigerian authorities have made a commitment to sustained macroeconomic stability and exchange rate flexibility.


    By 1983, triple-digit inflation and parallel market premiums, sharply negative growth, and a good portion of economic activity occurring outside legal channels brought Ghana’s economy to the brink of collapse. The Economic Recovery Program (ERP) of 1983–91 began with an effective 800 percent devaluation of the nominal exchange rate and very gradually liberalized the exchange and trade system by introducing foreign exchange auctions and the licensing of foreign exchange bureaus. The real exchange rate depreciated throughout the period, correcting overvaluation and responding appropriately to declines in the terms of trade. Substantial progress was made in controlling fiscal and monetary policies, although inflation remained quite variable. Although stabilization successes were impressive, real economic growth recovered to an average of only 2 percent during this period, related to the weak private investment response to the reforms. Loss of fiscal control began again in 1992, as large civil service wage increases associated with the elections rekindled inflationary expectations. Inflation reached 70 percent in 1995 (1996 was another election year), but it decelerated to 14 percent by end-1999. However, rapid cedi depreciation in late 1999 and 2000 brought inflationary pressures back to the 30 percent level.

    The real exchange rate has been appreciating since 1995, eroding Ghana’s competitiveness relative to Côte d’Ivoire, its CFA neighbor and fellow cocoa exporter. By 1999, there was a concern that the increasing appreciation would negatively affect the strong growth in nontraditional exports. The real depreciation during 2000, however, has returned the currency to the most competitive level over the last decade.

    The process of broadening access and improving the efficiency of the exchange market continued under the Economic Recovery Program, taking another step forward in 1992 with the replacement of the foreign exchange auction with an interbank market. Currently, however, the market is still experiencing operating problems, as it is actually a market between the central bank and the commercial banks, rather than a true interbank market.

    Following some improvement in fiscal control in 1998, Ghana suffered a major terms of trade shock in 1999, as world prices for its main exports (cocoa and gold) plummeted and oil prices doubled. Neither fiscal nor monetary policies responded appropriately, however. The government maintained too high a cocoa price for farmers that severely compromised revenue from cocoa taxes and borrowed from the banking system to fill the resulting higher deficit. Fearing that rapid depreciation would further stoke inflation, the Bank of Ghana (central bank) intervened in the foreign exchange market to slow nominal depreciation. This strategy was finally forced to end by November 1999, when reserves were run down to dangerously low levels.

    The Gambia

    Economic activity in The Gambia began declining in the late 1970s. The exchange rate, pegged to the pound sterling, became increasingly overvalued. Oil price shocks, low world market prices for groundnuts, and a long drought in the Sahel contributed to the economic decline as did excessive domestic borrowing and money creation to finance the fiscal deficit. The overvalued currency discouraged the surrender of export proceeds to the official banking system, inducing a growing external indebtedness and depletion of gross official reserves. In addition, external payment arrears and a large parallel market emerged.

    The centerpiece of the Economic Recovery Program (ERP) beginning in 1986 was the flotation of the Gambian currency (dalasi), resulting in a nominal depreciation of approximately 78 percent and the removal of restrictions on foreign exchange transactions. Government policy reforms in other areas supported the exchange market reforms: liberalization of controls on prices and interest rates, and large reductions in the budget deficit. A large inflow of foreign aid is also credited as having helped stabilize the exchange rate. The reform has been judged as an example of quite rapid stabilization due to a combination of good policies, luck (end of drought), and aid (Radelet, 1993; McPherson and Radelet, 1991).

    Following the large real depreciation in 1986, there was some appreciation of the real exchange rate until 1990.

    The 1994 coup led to a sharp drop in aid, and a reduction in tourism receipts and problems for the re-export trade—both increasingly important sectors of the economy. The Gambia’s loss of competitiveness with Senegal after the 1994 CFA devaluation (and the imposition of border controls by Senegal until 1996) also hurt re-export trade. Output declined by 3.4 percent in 1994–95. After picking up in 1995–96, economic performance deteriorated again in 1996–97, a period of transition from military to civilian rule, as the government made inappropriate policy responses to adverse shocks—primarily through an overly expansionary fiscal stance. The economy began to improve in 1998, although substantial governance problems occurred in 1999 as the government seized the Gambia Groundnut Corporation, incurred excessive debt, and engaged in suspicious extrabudgetary spending. Still, the budget deficit was brought down from 12 percent in 1995–96 to 4.8 percent in 1998–99, and inflation remained relatively low.

    The market-based flexible exchange rate is viewed as having served the economy well. There has been no major deterioration in competitiveness since 1990 based on the real exchange rate, although the 1994 CFA devaluation improved Senegal and Mali’s relative competitiveness. Government intervention in the foreign exchange market has been limited to smoothing exchange rate fluctuations and minimizing reserve losses. However, the existence of a 10 percent spread between the parallel and interbank market reveals limited competition in the interbank market and the need for its further development.


    Until 1984, Guinea had a centrally planned, command economy system, with nearly the entire formal sector controlled by a large, inefficient public sector sustained by royalties of foreign-owned bauxite companies. A comprehensive reform program, including liberalization of the foreign exchange system, made progress in transitioning to a market economy during 1985–95. GDP growth increased to an annual average of 4 percent. The fiscal position improved impressively given the cumulative decline in bauxite and alumina prices, which were the major source of government revenue.

    From 1986–94, a managed float through an auction market determined the exchange rate. It has been judged as a successful exchange rate based stabilization (Azam and Diakité 1999). The central bank adopted a relatively low rate of crawl, independent of the parallel rate, and inflation declined from 65 percent in 1986 to 4 percent in 1994. The credibility of the anti-inflation policy has been substantially credited to the strong personality of the governor of the central bank, Kerfalla Yansane. Together with a relatively tight domestic credit policy, this enabled the accumulation of foreign exchange reserves, used for exchange rate based stabilization, even against the background of deteriorating terms of trade.

    The economy deteriorated somewhat in 1996, due to problems associated with a failed mutiny by the army. Broad macroeconomic equilibrium was maintained, however, and the overall budget deficit (including grants) was less than 3 percent. External developments created difficulties beginning in the second half of 1998 when the Asian crisis triggered a sharp fall in prices of bauxite and alumina; deteriorating security in neighboring countries Sierra Leone, Guinea-Bissau, and Liberia required the government to spend substantial amounts on peacekeeping troops; and uncertainty about stability surrounded the December 1998 elections. The government financed the deteriorating fiscal balance in 1999 by borrowing from the central bank.

    From 1994–99, the exchange rate was determined in an interbank market, although in recent years the government has intervened excessively to keep the rate artificially high. Before September 1999, the foreign exchange market was highly segmented. State enterprises and donors, operating through two large banks, and large importers dominated an official market. Remaining transactions took place in a so-called parallel market of foreign exchange bureaus, which actually have official status. The spread between the two rates ranged from 4–6 percent until mid-1998, when the spread began widening and market segmentation became more pronounced, with “shortages” in the parallel market while those with access to official rates earned substantial rents. The central bank introduced a weekly auction for foreign exchange, which helped to reduce the spread significantly, and since end-1999 it has fluctuated between plus or minus 3 percent. The introduction of a foreign exchange auction also led to a depreciation of 26 percent in the last four months of 1999, but since then the official rate has appreciated.

    Cape Verde

    From 1975–91, Cape Verde pursued an inward-oriented, activist development strategy based on central planning and an economically dominant public sector. Still, relatively prudent policies (and large foreign transfers) allowed economic growth to proceed at a solid pace through the 1980s. By the late 1980s, aid and remittances began declining. Rather than cutting large expenditures, the government used bank credit to finance deficits. Unemployment and inflation rose, and official reserves fell. Movement toward a more market-oriented economy began in 1992, with an adjustment program adopted by a new government under a new constitution. The reforms restored reasonable growth, with significant contributions from services and foreign investment in export-oriented manufacturing. Until 1997, however, fiscal policies were unsustainably lax, leading to accumulation of domestic debt and depletion of foreign exchange reserves to levels covering as little as one-half month’s worth of imports in 1996.

    Cape Verde began a precautionary arrangement with the IMF in 1998, with the objectives of reducing fiscal imbalances, privatizing, lowering domestic debt, and liberalizing the trade and exchange rate system. Rapid progress followed: real GDP growth increased to 8 percent in 1998–99 and inflation was halved from 8.6 percent in 1997 to 4.3 percent in 1999. Current account and capital transactions were liberalized in mid-1998, policies aimed at ensuring the convertibility of the Cape Verde escudo. In order to signal a commitment to low inflation and macro-economic stability, the basket peg was replaced with a fixed link of the Cape Verde escudo to the Portuguese escudo and, since 1999, a peg to the EU’s common currency, the euro.

    Spending overruns worsened the fiscal situation in the second half of 1999. Given the currency peg, this immediately put pressure on international reserves. The authorities responded inappropriately by temporarily introducing foreign exchange rationing. The fiscal overruns were partially financed by credit from the central bank and also from a credit line facility with Portugal. The periods of fiscal deterioration—and their impact on prices, reserves, and investor confidence—show up clearly in appreciations of the real exchange rate in 1997 and the second half of 1998. Prior to this period, during the 1990s, the real exchange rate had been relatively stable.


    Liberia’s economic situation deteriorated in the 1980s following terms of trade declines, economic mismanagement, and mounting arrears that led to a breakdown of relations with creditors and donors. The 1989–97 civil war brought most economic activity to a virtual standstill. Following a peace agreement and democratic elections in 1997, the post-conflict recovery has been quite strong: real GDP doubled in 1997 and grew by 30 percent in 1998, bringing domestic production back to one-third of the pre-war level. This was largely due to recoveries in agriculture, forestry, and rubber, although not in the important iron ore sector.

    The U.S. dollar is legal tender and the Liberian dollar was held at a fixed one-for-one parity until August 1998, when the rate became market determined. This change was made given the country’s vulnerability to external shocks and lack of reserves. In March 2000 a new Liberian dollar replaced the Liberty and JJ Roberts notes. The exchange and trade system was liberalized in 1997–98, including an elimination of government monopolies on exporting of cash crops and elimination of foreign exchange surrender requirements on agricultural exports.

    A new central bank was established in November 1999. For now, the central bank will not extend credit to the government and issuance of currency will be limited to exchange for the existing stock and the purchase of foreign currency to begin to rebuild international reserves. Thus, with a fixed stock of money and an illiquid central bank, monetary policy has had little scope. The exchange rate and inflation remained stable in 1998–99 in the context of a balanced fiscal position (cash basis) and fixed supply of currency. However, there was a substantial deterioration in the fiscal position during 1999 due to extrabudgetary expenditures, which has since been corrected.

    Sierra Leone

    Sierra Leone’s economic situation spiraled downward in the 1980s in the context of pervasive government control and intervention. Budget deficits (financed by money creation) averaged more than 12 percent, causing inflation to spiral and peak at 167 percent in 1986–87. The parallel market premium also reached triple digits, so that potential revenue from the mining sector was lost through smuggling and tax evasion, while the overvalued exchange rate and import subsidies led to smuggling of imports out to neighboring countries. An attempt at an adjustment program in 1986–87—which included an exchange rate float—failed.

    A full-scale reform program began in 1989–90, with significant liberalization of the exchange and trade system, beginning in 1990, as the program’s centerpiece. The parallel and official exchange rates were effectively unified through a float in an interbank market, with a large initial nominal depreciation. The real exchange rate, which exhibited massive fluctuations in the 1980s, depreciated with the liberalization of 1990 and since that point the size of changes has been substantially smaller. Overall results of the reform process were initially mixed as weak fiscal discipline contributed to monetary instability. By 1992, however, the successful exchange liberalization began to attract foreign assistance and the fiscal situation improved, leading to a buildup of reserves and a fall in inflation. It was still very difficult to register any improvements to growth during this period, however, as the economic infrastructure in mining and agricultural exports had nearly collapsed after years of neglect and rebel-related disruptions.

    Rebel conflicts and civil war, during which rebels seized the rutile and bauxite mines that generated most export earnings and sizable parts of government revenues, caused the economic situation to deteriorate from 1992. Some gains in stabilization and economic recovery were achieved following the peace agreement and elections of 1996, but the country has subsequently been reengulfed by civil war.

    Appendix II Existing and Failed Currency Unions

    Eastern Caribbean Currency Union

    The ECCU consists of eight small island countries: Anguilla, Antigua and Barbuda, Dominica, Grenada, Montserrat, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines.1 Except for Anguilla and Montserrat, they are independent countries. Population ranges from 41,000 in St. Kitts and Nevis to 140,000 in St. Lucia (Randall, 1998). The countries have traditionally been primary commodity producers (banana, sugar, root crops), but tourism is now the most important source of foreign exchange earnings. Collectively, the GDP of the eight-member ECCU was $2.5 billion in 1998, with per capita income ranging from $2,700 in St Vincent and the Grenadines to $8,700 in Antigua and Barbuda.

    The ECC Authority was formed in 1965 as the monetary authority for ECCU members and replaced in 1983 by the Eastern Caribbean Central Bank (ECCB). The Eastern Caribbean dollar (EC$) was initially pegged to the pound sterling. In 1976, the Eastern Caribbean dollar was pegged to the U.S. dollar at the then prevailing cross rate of EC$2.70/US$1, which remains in effect.

    There is a single central bank for the monetary union and a single monetary policy. The ECCB operates as a quasi currency board, in which lending to member governments is strictly limited by statute and 60 percent of its monetary liabilities are required to be backed by foreign currency assets. In practice, the foreign exchange cover has been considerably higher, usually in excess of 95 percent in recent years. Foreign assets are part of a common pool and are not assigned to individual countries.

    The main monetary policy objective is to maintain foreign exchange cover. The main policy tool is domestic credit expansion.

    The ECCB has maintained a uniform reserve requirement of 6 percent since its inception, although it has the power to change it. In 1984, the ECCB established a facility for “bankers’ fixed deposits” in U.S. dollars, which pay competitive rates.

    There are 44 commercial banks operating in the area, of which six are “branch banks” of foreign banks that have continued since independence and that typically operate separately and independently in several countries of the region. The remaining 38 banks are locally incorporated and include government-owned, private, and locally incorporated branches of foreign banks. They are subject to minimum capital requirements, and in 1995 the regulations for loan loss provisioning were tightened.

    There are restrictions on the flow of funds both within and outside the ECCB area. The current limit on purchases of foreign exchange for invisibles and capital transactions is EC$250,000, but all bona fide requests are honored. There is not a uniform regime with respect to the capital account, with each member applying some restrictions both with respect to transactions with other members and nonmembers, to varying degrees. Restrictions on capital flows have in the past impeded the creation of a single money market and contributed to the segmentation of the regional banking market and the persistence of large spreads between lending and deposit rates as well as differences in rates across countries (Randall, 1998).

    Internal trade of the area is small. Although complete data are not available, a rough estimate suggests that less than 10 percent of ECCU members’ total trade is accounted for by trade within the region (IMF, Direction of Trade Statistics, 1999).

    The Euro Area

    The current members of the euro area are Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain. Other current and prospective European Union (EU) members are expected to join over the coming decade. At the formation of the euro area in 1999, the member countries accounted for 15.5 percent of world GDP and 32 percent of world exports (IMF 1999, Statistical appendix Table A).

    The euro area was formed after a long transition period and the prior creation of a customs union (1957) and a single market for goods and factors (1986). The Werner Report of 1970 recommended a monetary union among (then) European Community members by 1980. In 1979, the formation of the European Monetary System enhanced exchange rate cooperation, creating margins of fluctuation around fixed but adjustable central parities, and credit facilities for intervention. In 1989, the Delors Report gave fresh impetus to the regional integration project, leading to the signing of the Maastricht Treaty on European Union in February 1992. The absence of capital account restrictions (remaining ones had been removed by 1990) and uncertainty about ratification of the Treaty led to speculative attacks against a number of EMS currencies in the September 1992–July 1993 period, the withdrawal of the Italian lira and pound sterling from the exchange rate mechanism, several devaluations of other central parities, and the widening of the bands of fluctuation to plus or minus 15 percent at the beginning of August 1993.

    Despite the fact that the EU consists of advanced countries that all have high per capita incomes, diversified economies, relatively low inflation, and a long history of cooperation, the Treaty mandated a long transition period in which countries had to prove that they had converged to low fiscal deficits, low inflation and interest rates, and exchange rate stability.

    Monetary financing of governments is strictly prohibited by the Treaty. Moreover, the constraints on fiscal policy upon joining monetary union were further strengthened by agreement on the Stability and Growth Pact, which included provisions for assessing sanctions of up to half a percent of GDP on countries exceeding the deficit ceiling of 3 percent of GDP.

    The euro is fully convertible on current and capital accounts.

    Monetary policy is determined by the European Central Bank, on whose Governing Council each of the member countries is represented. There is a single monetary policy and set of official interest rates for the entire zone. Monetary policy is implemented in part by the national central banks; together, the ECB and national central banks make up the European System of Central Banks, Foreign exchange reserves are partly pooled and partly retained by national central banks.

    The objective of monetary policy is to maintain price stability, and, subject to that objective being achieved, to support EU economic activity. Direct or indirect monetary financing of governments is prohibited. The main policy instrument is the interest rate on advances to commercial banks. Monetary policy is built on two “pillars”: targets for the growth of a monetary aggregate (M3) and for inflation. There is no target for the external value of the euro, which fluctuates against other major currencies.

    Economic activity in the countries of the euro area is very integrated, with countries’ production being relatively similar and very diversified. Internal trade within the region in 1998 was 46 percent of both imports and exports of member countries (IMF, Direction of Trade Statistics, 1999).

    Other policies and institutions supporting regional integration in the EU include the common market, European Court of Justice, European Coal and Steel Community, Single European Act, Common Agricultural Policy, and extensive harmonization of regulations in a number of areas.

    The CFA Franc Zone in Africa

    The CFA franc zone is composed of two zones of mainly Francophone countries in West and Central Africa. The West African CFA zone is the West African Economic and Monetary Union (WAEMU) or l’Union Economique et Monétaire Ouest Africaine (UEMOA), with its central bank, the Banque Centrale des Etats Ouest Africains (BCEAO). The Central African CFA zone is the Central African Economic and Monetary Community (CAEMC) or Communauteé Economique et Monétaire de l’Afrique Centrale (CEMAC), with its central bank, the Banque des Etats de l’ Afrique Centrale (BEAC). The WAEMU members are Benin, Burkina Faso, Côte d’Ivoire, Guinea-Bissau, Mali, Niger, Senegal, and Togo while Cameroon, Central African Republic, Chad, Congo, Equatorial Guinea, and Gabon are members of CAEMC.

    Each regional grouping issues its own CFA franc, but they are exchangeable one-for-one against each other. The convertibility of the CFA franc at its parity against the French franc (100 CFAF=1 FF) is provided by the French Treasury through an Operations Account, where overdrafts are potentially unlimited. The CFA franc has been pegged to the euro since 1999 via its French franc peg. (The Comoros also pegs its currency, the Comorian franc, to the French franc and, since 1999, to the euro.) The current institutional arrangements for monetary policy in the CFA zone were established by treaties among members and France in 1972–73, but the CFA franc goes back to the second world war, when French colonies in Africa were grouped into two zones. The parity against the French franc remained constant from 1948 to 1994, when it was devalued from 50 CFA francs per French franc to 100 CFA francs.

    For each of the two zones, member countries’ reserves are held in separate Operations Accounts with the French Treasury. Each zone is required to hold external assets at least equal to 20 percent of the central bank’s sight deposits. If that threshold is breached, the central bank needs to take extraordinary measures to correct the situation. The West African CFA zone was in deficit from 1980–84 and again from 1988–89, but the overall position in the operations account of the two zones together has only been in (small) deficit in 1983, 1987, and 1988. Since the 1994 devaluation, the positions of the two zones have been in substantial surplus.

    The regional Council of Ministers and the central banks’ Boards decide monetary targets, on the basis of submissions from national monetary authorities, subject to a limit on central bank financing of each government equal to 20 percent of the previous year’s budgetary revenues. The central banks’ main policy tool has been rediscount ceilings. However, bank credits for marketing, stockpiling, and crop exports were not included in the BEAC’s rediscount ceilings, and in the 1980s and early 1990s this constituted a source of monetary expansion outside the central bank’s control, especially to the largest CAEMC country, Cameroon. These credits were re-discounted automatically and at concessional rates (Nascimento, 1994). A similar situation existed in the West African zone, where the larger countries (Côte d’Ivoire and Senegal) avoided direct controls on financing by borrowing from commercial and development banks, which could obtain refinancing from the BCEAO at concessional rates. The lack of control over these credits opened the door to excessive lending to governments, despite respect of the formal ceilings on direct financing. As a result, existing rules did not achieve fiscal discipline (Stasavage, 1996). Excessive fiscal deficits developed in both zones, exacerbating overvaluation of the CFA franc related to terms of trade shocks and the appreciation of the French franc against the U.S. dollar in the 1987–93 period. Since prudential ratios on banks were not adequately enforced, a banking crisis occurred in both zones in this period and the central banks, which had extended loans to the banks, ended up the major creditors. In effect, the larger countries, which had benefited from the commercial bank loans, obtained seigniorage (Stasavage, 1996; Nascimento, 1994).

    The overvaluation and general recession led to the crisis and devaluation of the CFA franc in January 1994.

    Current account convertibility, although established in principle, is in fact subject to restriction. For instance, the repurchase by the central banks of their bank notes circulating outside the zone was suspended during the exchange rate crisis in July 1993 and has never been restored. Within the zone, there are no restrictions on capital movements, but there are few capital flows given the poor state of banking systems. The creation of a unified money market in WAEMU, an objective for a number of years, has in principle been achieved, but transactions are few. Most of the capital account transactions between residents of the zone and nonresidents are now subject only to a declaration for statistical purposes (December 1998 uniform exchange regulations).

    The importance of trade among the countries of the two zones is limited (and, even more so, between them). Intra-WAEMU imports and exports are estimated to be about 12 percent of the region’s total trade, while for CAEMC, the estimate is about 6 percent (Hugon, 1999). IMF Direction of Trade Statistics give lower figures (see Table 6.1 on page 20).

    Currency union in the two zones was paralleled, to differing extents, by other institutions of regional integration. Before 1994, integration largely consisted of attempts at creating preferential trading areas. In West Africa, the West African Economic Community (WAEC) was founded in 1973, in response to the drawbacks of a predecessor customs union that attempted unsuccessfully to create a preferential internal regime in the absence of a common external tariff. WAEC created more adequate instruments of compensation for lost tariff revenues through a regional tax, the Taxe de Coopération Régionale. In 1994, WAEC was superseded by WAEMU, which established economic and monetary union, and has since put in place a common external tariff, introduced convergence criteria, and established a degree of surveillance over fiscal policies.

    Regional integration has been slower in Central Africa. The Treaty creating CAEMC, signed in 1994, was finally ratified in June 1999. Although reforms pushed by its predecessor organization were in principle achieved (creating a common external tariff and a preferential internal tariff and the harmonization of indirect and business taxes), in fact they have been unevenly applied. Institutional development in CAEMC has not proceeded as fast as in WAEMU, although there are projects for enhancing intraregional surveillance in CAEMC too (Bank of France, 1999).

    The Common Monetary Area

    The Common Monetary Area (CMA), or Rand Area, is composed of South Africa, Namibia, Lesotho, and Swaziland. The CMA is accompanied by a long-standing customs union, the Southern African Customs Union (SACU), with free circulation of goods internally and a common external tariff. Botswana left the CMA in 1976 but has remained a member of SACU. Labor mobility is relatively low between the smaller countries and South Africa (Tjirongo, 1998).

    Each CMA country has its own currency, but given the size and degree of development of the three smaller members, the Reserve Bank of South Africa sets monetary policy. The three other countries’ central banks function as currency boards, issuing their own currencies, but they are required to back their own currencies 100 percent with foreign assets. The South African rand circulates in each of the smaller countries (and is legal tender in Lesotho and Namibia).

    The Reserve Bank of South Africa has generally avoided providing monetary financing and has achieved relatively low inflation. The rand floats against the major currencies and monetary policy is guided by an inflation target.

    Miscellaneous Asymmetric Monetary Unions

    Examples of asymmetric monetary unions, whereby one country takes a leadership (hegemonic) role, are as follows:

    • The Belgium-Luxembourg Economic Union (BLEU) has linked Belgium and Luxembourg since 1922. The countries issue separate currencies, exchangeable at par; Belgian currency is legal tender in Luxembourg but Luxembourg currency is not legal tender in Belgium. Currency union has been superseded since 1999 by the membership of both countries in a larger monetary union, the euro area. Monetary creation was controlled by the National Bank of Belgium, but Luxembourg had an input into decisions.

    • The U.S. dollar is the medium of exchange in Panama, while the Panamanian currency (balboa) is a unit of account and exists only as silver coins. Panama has no influence over its monetary policy. While this has led to low interest rates (comparable to those in the United States), it also exposed Panama to freezing of U.S. accounts, leading to closure of Panama’s banking system for two months in 1988, during the Noriega period (Moreno-Villalaz, 1999).

    Failed Currency Area: The Ruble Zone After the Demise of the Soviet Union

    In the period prior to the break-up of the republics of the former Soviet Union and creation of the Commonwealth of Independent States (CIS) in 1991, separate republics had their own central banks. With the breakdown of central planning, control over the central banks’ monetary expansion also broke down.

    The ruble was an inconvertible currency whose internal convertibility was not even assured, making the ruble a poor medium of exchange. Incentives for excessive monetary expansion by each republic’s central bank and lack of a centralized monetary policy led to uncontrolled inflation, making the ruble a poor store of value. Therefore, although the other CIS republics were heavily dependent on trade with Russia and not sufficiently advanced to create convertible currencies, they were led to introduce their own inconvertible currencies to be insulated from the monetary instability in Russia.

    The other CIS republics, which were mainly oil importers, also faced different terms of trade shocks from Russia, an oil exporter, making separate currencies desirable (Gros, 1993).

    The East African Community

    The East African Community (EAC) was formed by countries (Kenya, Tanganyika, and Uganda) that had a common currency, the East African shilling, under Britain’s colonial rule.

    In the 1960s, after independence, each country issued its own currency, but the EAC in 1967 specified free exchange between the national currencies at par.

    After 1966, the rules of the currency board were loosened, giving governments more influence on their central banks and removing the floors on official reserves. Limits on advances to governments were undermined and credit was channeled to governments and public sector entities indirectly via the commercial banks (Guillaume and Stasavage, 2000).

    In 1977, all three governments extended exchange controls to each other’s currencies, effectively abolishing the monetary union (Cohen, 1998, p. 73).

    Appendix III Comparative Performance of the CFA Franc Zone

    There is now an extensive literature on whether the existence of a currency union in WAEMU and CAEMC has enhanced or hindered economic performance. A partial survey of this literature follows. Many studies have considered effects on intraregional trade, while others have examined broader aspects of economic performance, in particular growth and inflation. Some studies have quantified the effects of monetary union by doing a regression analysis on a cross-section of countries, including other structural determinants of performance, and tested for a significant difference in performance between members of monetary unions and nonmembers (e.g., by including a dummy variable for monetary union). Others have used a control group approach, looking at the average performance of CFA franc zone countries vis-à-vis a representative sample of comparable countries (e.g., other sub-Saharan African countries). In both cases, there is a potential problem of endogeneity; for instance, a third factor may explain why countries with better performance may also be members of monetary unions. Elbadawi and Majd (1996) correct for this endogeneity using a modified control group approach.

    Effects on Trade

    The standard framework for considering the effect of membership in a monetary union on internal trade is the gravity model, which explains the extent of bilateral trade in either direction between a pair of countries by their respective size and per capita income (both affecting trade positively) and distance between them (negatively). Other variables can be included, such as whether the countries are contiguous, share a common language, have a common colonial past, or are part of a free trade area. In particular, we focus on the effect of a monetary union dummy variable.

    Internal trade of the two CFA zones seems to be low—about 9 percent of their total trade for WAEMU countries and 3 percent of total trade for CAEMC countries—but low relative to what? The gravity model in fact predicts that their trade should be low, given levels of per capita income and total GDP. In contrast, the much higher income of EU countries exerts a strong “gravitational pull,” which helps explain the large trade share of EU countries with the CFA zones. Consistent with this, trade among all pairs of sub-Saharan African countries tends to be low, whether members of monetary unions or not.Foroutan and Pritchett (1993) find that intra-African trade is no different from trade between other low- and middle-income developing countries. This conclusion is supported by Coe and Hoffmaister (1999), Rodrik (1999), and Subramanian and Tamirisa (2000).

    Tests of the effects of membership in the CFA franc zones are mixed. Unfortunately, since the preferential trading arrangements overlap almost perfectly with the CFA zones, both sets of effects are captured. Foroutan and Pritchett (1993) find a significant positive effect on trade of the West African CFA zone, but not the Central African one. Elbadawi (1997) provides estimates for 1980–84 and 1986–90, finding that membership in the (then) West African Economic Community (WAEC) regional grouping had a significant positive effect on internal trade in the first subperiod (increasing it by a factor of 32!), but a significant negative effect in the second (dividing it by 3). He concludes that effects are very much dependent on the interplay of the policy stance and membership in monetary union, as well as external factors (in particular, for the CFA franc zones, the fact that the French franc appreciated against the U.S. dollar in the second subperiod). As for the Central African CFA zone, membership did not seem to have a significant effect on trade for the countries concerned, consistent with the results of Foroutan and Pritchett.

    Laporte (1998) also gets a significant and positive effect of WAMU membership on trade of the region. Moreover, the size of the effect increases over the three subperiods he considers (an elasticity of 3.49 in 1970–72, 3.90 in 1979–81, and 5.87 in 1989–91), which he explains by strengthening economic cooperation accompanying the monetary union, Subramanian and Tamirisa (2000) also find a significant positive effect of CFA franc zone membership (both zones), using data for 1990, but the elasticity is estimated to be much smaller, only 1.68. For both studies, the dummy variable estimation does not permit distinguishing CFA franc zone membership from other forms of regional cooperation.

    A larger set of countries could in principle distinguish between the two, since there are other monetary unions (e.g., the Eastern Caribbean Currency Union) that are not accompanied by preferential trading arrangements. Rose (2000) provides estimates of a gravity equation using all available United Nations data on 186 countries, dependencies, and territories; he includes dummy variables for both regional trade agreements and membership in a currency union. He concludes that the effect of the latter is significantly positive and robust, and membership in a monetary union multiplies bilateral trade of any two countries on average by a factor of three.

    A different approach to quantifying effects on trade is provided by Guillaumont and Guillaumont-Jeanneney (1993), who look at the growth rate of bilateral trade relative to market growth for various groupings of countries (including CFA franc countries) and a control group of other developing countries. They find a significant effect of membership in the West African monetary union (and the associated trade arrangement) but none for the Central African monetary union. They suggest that the favorable effect on trade integration of monetary union is not automatic, but rather depends on the degree of solidarity of member countries.

    Effects on Output and Inflation

    Studies on the wider effects of CFA franc membership underscore the very different performance of the zones in the years before and after 1985. Earlier studies (Guillaumont and Guillaumont, 1984; Devarajan and de Melo, 1987) had suggested that membership brought both higher growth and lower inflation. But Devarajan and de Melo (1992) highlighted the sharp difference between the 1986–90 period and earlier. They conclude that the later poor performance was due to inadequate policies in the face of negative terms of trade shocks and appreciation of their nominal (and real) effective exchange rates: “In principle, CFA Zone members have enough instruments with which to adjust their economies … In practice they have been reluctant to use these other instruments.” (p. 31). The conclusion that inflation performance was better for CFA zone members but growth was worse is robust to adjusting for endogeneity of regime choice (Elbadawi and Majd, 1996).

    Another relevant study, byHoffmaister, Roldós, and Wickham (1998), finds that terms of trade shocks have a greater influence on output in CFA countries, due to an exchange rate regime that does not buffer shocks.


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    The meeting was attended by three heads of state. Presidents Olusegun Obasanjo of Nigeria. Jerry Rawlings of Ghana, and Lansana Conte of Guinea, as well as representatives from Liberia. Sierra Leone, and The Gambia, Cape Verde, the remaining non-CFA ECOWAS member, has a currency peg to the euro with the support of Portugal, and was not a signatory of the “Accra Declaration on a Second Monetary Zone.” Mauritania, a founding ECOWAS member, recently withdrew from the regional organization.

    CFA stands for “Communaute’ financiere africaine” when it refers to the West African franc zone.

    ECOWAS, or Economic Community of West African States, is composed of the seven countries mentioned in the first footnote, plus the eight countries that are members of the West African Economic and Monetary Union—namely, Benin, Burkina Faso, Côte d’Ivoire, Guinea-Bissau, Mali, Niger, Senegal, and Togo.

    Guinea and Mali left the CFA zone upon independence, but Mali later rejoined.

    WAEMU is an eight-member economic and monetary union. The French acronym for WAEMU is UEMOA (l’Union Economique et Monétaire Ouest Africaine). The common currency of the WAEMU countries, the franc de la Communauté financière de l’Afrique (CFA franc), is issued by a single central bank, the Banque Centrale des Etats de l’Afrique de l’Ouest (BCEAO). WAEMU’s CFA franc is pegged to the French franc, which since 1999 has been a subunit of the common European currency (euro).

    The French Treasury currently has sole responsibility for guaranteeing convertibility of CFA francs into euros, without any monetary policy implication for the Bank of France (French central bank) or the European Central Bank. The two CFA central banks maintain an overdraft facility with the French Treasury, subject to operating rules that have applied since 1973. Each CFA central bank must keep at least 65 percent of its foreign assets in its operations account with the French Treasury; provide for foreign exchange cover of at least 20 percent for its sight liabilities; and impose a cap on credit extended to each member country equivalent to 20 percent of that country’s public revenue in the preceding year.

    The impetus for monetary union also seems to have been stimulated by the formation of the euro zone. See Irving (1999).

    Defined as total revenue, excluding grants, minus total expenditure, excluding development projects directly financed by external resources, generally on concessional terms.

    Final Communiqué, Eleventh Extraordinary Session of the Committee of Governors of the Central Banks of the Member States of the Economic Community of West African States (ECOWAS). Dakar, May 4–5, 2000.

    The West African Unit of Account (WAUA) is linked one-for-one to the special drawing right (SDR). At the May 2000 meeting, central bank governors endorsed the WAUA as the numeraire for evaluating exchange rate stability. Use of the WAUA has largely been restricted to accounting purposes within the ECOWAS bureaucracy.

    At present the WAEMU treaty coexists with the WAMU treaty but is expected to replace it eventually.

    There are signs of recent progress in this area. For example, the Bourse Régionale des Valeurs Mobilières, the regional stock exchange for the WAEMU countries, reportedly is working with the West African Development Bank to introduce new types of bond instruments to attract more small, local investors.

    Secondary criteria are that the public sector wage bill should not exceed 35 percent of revenues, investment financed by domestic resources should be at least 20 percent, government revenue should be at least 17 percent of GDP, and the external current account deficit (excluding grants) should be no more than 5 percent of GDP.

    Data for WAEMU here exclude Guinea-Bissau, since it did not join until 1997.

    Pinto (1991) formalized this expectation, by showing that when the government is a net purchaser of foreign exchange from the private sector, official overvaluation constitutes a large implicit tax on the exportable sector, and unification of the official and parallel market will lead to higher steady state inflation as the government substitutes a higher inflation tax for the lost implicit revenues. Morris (1995), however, showed that when the public sector has a net inflow of foreign exchange, for any given level of government spending, exchange rate unification reduces recourse to central bank financing, hence lowering domestic money creation and inflation.

    This may have partly resulted from the peg to the French franc (which appreciated against the U.S. dollar over the period), rather than the monetary union among African countries.

    Much of this literature was written in the context of European monetary integration, although Robert Mundell’s seminal article (Mundell, 1961), which launched the idea of “optimum currency areas,” referred to Canada and the United States, It needs to be recognized that the various criteria for optimum currency areas do not have much predictive power when it comes to actual exchange rate regimes. In addition, as noted by Frankel and Rose (1998), these criteria are to some extent endogenous: membership in a monetary union may help make the shocks hitting member countries more symmetric and also expand intra-union trade.

    The evidence that internal WAEMU trade is higher as a result of the common currency is surveyed in Appendix III. Bilateral trade among ECOWAS countries is expected to be small, given the small size of their economies and low per capita income.

    “ECOWAS Monetary Zone: Compensation Fund Underway,” This Day (Lagos), July 10, 2000, and ECOWAS Press Releases No. 94/2000 and No. 98/2000. As noted above, WAEMU has already established structural funds for subregional development.

    Dating the start of the convergence process in the European Union is difficult, given that some of the stages (e.g., removal of capital controls by 1990) antedated signing of the Treaty, and the creation of the European Monetary System in 1979 was intended as stage I of a transition to monetary union. Formal convergence programs were first introduced in 1992.

    In particular, exchange rate stability was required for two years, though the widening of the bands of fluctuation made this condition less constraining from August 1993. The general government debt criterion also stipulated that the trend was important, not just the level at a particular point in time.

    “ECOWAS Single Currency Kicks Off,” This Day (Lagos), July 17, 2000.

    For reasons discussed above, none of the existing central banks or national currencies seems to have the needed track record of stability, making the creation of a new central bank and currency desirable should this scenario be implemented.

    See also the discussion of the decline in influence of the “credibility hypothesis” in Tavlas (2000).

    For a discussion of the new status of the CFA zone, see Gnassou (1999).

    The Dakar meeting of ECOWAS central bank governors in May 2000 endorsed the West African Unit of Account, which is linked one-for-one to the SDR, as the numeraire for evaluating exchange rate stability. However, it appears that this issue has not been definitively resolved and will be the subject of a study by the “interim institution,” to be created shortly.

    Recent Occasional Papers of the International Monetary Fund

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    177. Perspectives on Regional Unemployment in Europe, by Paolo Mauro, Eswar Prasad, and Antonio Spilimbergo. 1999.

    176. Back to the Future: Postwar Reconstruction and Stabilization in Lebanon, edited by Sena Eken and Thomas Helbling. 1999.

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    172. Capital Account Liberalization: Theoretical and Practical Aspects, by a staff team led by Barry Eichengreen and Michael Mussa, with Giovanni Dell’Ariccia, Enrica Detragiache, Gian Maria Milesi-Ferretti, and Andrew Tweedie. 1998.

    171. Monetary Policy in Dollarized Economies, by Tomás Baliño, Adam Bennett, and Eduardo Borensztein. 1998.

    170. The West African Economic and Monetary Union: Recent Developments and Policy Issues, by a staff team led by Ernesto Hernández-Catá and comprising Christian A. François, Paul Masson, Pascal Bouvier, Patrick Peroz, Dominique Desruelle, and Athanasios Vamvakidis. 1998.

    169. Financial Sector Development in Sub-Saharan African Countries, by Hassanali Mehran, Picro Ugolini, Jean Phillipe Briffaux, George Iden, Tonny Lybek, Stephen Swaray, and Peter Hayward. 1998.

    168. Exit Strategies: Policy Options for Countries Seeking Greater Exchange Rate Flexibility, by a staff team led by Barry Eichengreen and Paul Masson with Hugh Bredenkamp, Barry Johnston, Javier Hamann, Esteban Jadresic, and Inci Ötker. 1998.

    167. Exchange Rate Assessment: Extensions of the Macroeconomic Balance Approach, edited by Peter Isard and Hamid Faruqee. 1998

    166. Hedge Funds and Financial Market Dynamics, by a staff team led by Barry Eichengreen and Donald Mathieson with Bankim Chadha, Anne Jansen, Laura Kodres, and Sunil Sharma. 1998.

    165. Algeria: Stabilization and Transition to the Market, by Karim Nashashibi, Patricia Alonso-Gamo, Stefania Bazzoni, Alain Féler, Nicole Laframboise, and Sebastian Paris Horvitz. 1998.

    164. MULTIMOD Mark III: The Core Dynamic and Steady-State Model, by Douglas Laxton, Peter Isard, Hamid Faruqee, Eswar Prasad, and Bart Turtelboom. 1998.

    163. Egypt: Beyond Stabilization, Toward a Dynamic Market Economy, by a staff team led by Howard Handy. 1998.

    162. Fiscal Policy Rules, by George Kopits and Steven Symansky. 1998.

    161. The Nordic Banking Crises: Pitfalls in Financial Liberalization? by Burkhard Drees and Ceyla Pazarbaş1oğlu. 1998.

    160. Fiscal Reform in Low-Income Countries: Experience Under IMF-Supported Programs, by a staff team led by George T. Abed and comprising Liam Ebrill, Sanjeev Gupta, Benedict Clements, Ronald Mc-Morran, Anthony Pellechio, Jerald Schiff, and Marijn Verhoeven. 1998.

    Note: For information on the title and availability of Occasional Papers not listed, please consult the IMF Publications Catalog or contact IMF Publication Services.

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