Back Matter
Author: Mr. Ernesto Hernández-Catá and C. A. François1
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund
Language:
English
Keywords:
OP; investment ratio; country; CFA franc; common currency
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Abstract

Following a serious deterioration of the competitive position of the WAEMU region in the 1980s and the eary 1990s, the countries took steps that have led to a significant turnaround in economic activity, a drop in inflation, and increases in output, exports and investment. This study describes policy issues that the region continues to face and suggests how the WAEMU countries can address them.

Appendix I Comparison of Regional Integration: TheWAEMU and the European Union

The two regions present an interesting contrast. Forty years after the Treaty of Rome, the European Union (EU) has created a customs union and achieved extensive regional economic and political integration, but is only now moving to a single currency. By contrast, the West African Economic and Monetary Union has had a single currency for 50 years, but a common external tariff is still in the planning stages, and other aspects of regional integration are far less developed than in Europe. The extent of reported intraregional trade (as a proportion of total trade of member countries) gives a striking, though somewhat exaggerated,13 measure of the difference in trade integration between the two regions. Despite sharing a common currency, the countries of WAEMU trade little among themselves; most of their exports and imports are with industrial countries. In relation to total international trade, reported internal trade in the WAEMU is even significantly below that of the rest of Africa.

Intraregional Exports

(Percent of total exports)

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Source: IMR Direction of Trade Statistics (Washtngton), various years.

The WAEMU and the EU differ considerably in their regional institutional and legal structures. In Europe, security as well as political considerations have reinforced the economic rationale for integration and have given rise to intergovernmental bodies with clear supranational authority in particular areas. The European Commission has executive responsibility in such areas as trade negotiations and competition policy, the European Court of Justice has its own areas of jurisdiction, and the European Parliament is directly elected. In addition, the European Council can make decisions through qualified majority voting, helping to avoid paralysis of decision making in areas for which the European institutions do not have supranational authority. In the WAEMU, supranationality to date has effectively been limited to the central bank for the region (the BCEAO) and to the regional Banking Commission.

Since the creation of the WAEMU in 1994, which broadened the scope of the existing WAMU, a more ambitious form of regional integration is being put in place that will include surveillance over member country policies through the monitoring of convergence criteria. The criteria (discussed in the body of the text) resemble the fiscal criteria of the EU (budget deficits and debt), but are focused more closely on the composition of government expenditures: wage bill, elimination of arrears, and primary surplus. Sanctions may be imposed on countries that do not observe the criteria, although details have not been worked out. In contrast, the countries proceeding to Economic and Monetary Union in the EU will be subject to the Stability and Growth Pact, which contains detailed procedures and considerable fines for those countries running excessive fiscal deficits. In the WAEMU, the danger of excessive deficits is reduced by the existence of ceilings on each member governmentďs reliance on central bank financing. In effect, the fixed exchange rate link between the CFA franc and the French franc provides a tight constraint on money growth and budgetary profligacy.

In the European Union, the Treaty of Rome kicked off the integration process with a schedule for eliminating internal tariffs and quotas and moving to a common external tariff. These measures were accompanied by the management of agricultural production and important transfers to farmers in the context of the Common Agricultural Policy. By contrast, the WAEMU region has been slow to achieve a customs union. Tariffs were eliminated in 1996 on agricultural products, and preferential rates are applied on internally produced industrial goods. A common external tariff is scheduled to be phased in during 1998—2000.

Appendix II The Real Exchange Rate of the WAEMU

This appendix calculates several indices of the real exchange rate for the WAEMU as a whole during 1970–97. The WAEMU economies maintain a fixed nominal exchange rate vis-a-vis the French franc, which remained unchanged from 1948 to January 1994, when the parity was devalued by 50 percent. The following questions are examined: To what extent had the real exchange rate appreciated before the devaluation of 1994? Was the nominal devaluation effective in improving competitiveness, and, if so, did the improvement last in the years following the devaluation?

There are two main definitions of the real exchange rate: the external real exchange rate and the internal real exchange rate. The external real exchange rate is the ratio of a domestic price or cost index to a weighted average of the corresponding index in foreign countries. The real exchange rate as measured by relative prices may not be appropriate for measuring competitiveness in small open economies because the price of tradable goods is determined in world markets. Domestic price changes therefore do not necessarily reflect changes in production costs. Moreover, trade barriers drive a wedge between foreign and domestic prices of tradable goods, so that changes in trade policy will change the external real exchange rate even though production costs do not change. It is therefore preferable to calculate the external real exchange rate as a ratio of production costs. The ratio of domestic to foreign wages or unit labor costs is often chosen because labor costs represent the largest proportion of total production costs.

The terms of trade have also been used as a measure of the external real exchange rate. This approach is based on the assumptions that the export price proxies the domestic deflator and that the import price proxies the foreign deflator. However, the first assumption is not expected to hold for small economies with undiversified exports, as is the case for the economies in the WAEMU that export primary products. In this case, the export price index is not representative of domestic prices because it measures the prices of only a few commodities. Furthermore, both the export and import price components of the terms of trade are determined in world markets, and changes of the nominal exchange rate therefore have no impact on them.

The internal real exchange rate is the ratio of the price of nontradable goods to the price of tradable goods. This measure relies only on domestic price indices and may therefore be more appropriate for small economies with relatively high trade barriers. The price of nontradables is influenced by their cost of production and may thus be more relevant as a measure of competitiveness.14

This appendix provides estimates of the external and internal real exchange rates for the WAEMU. The external real exchange rate is measured here as the ratio of domestic to foreign consumer price indices (CPI). Unfortunately, owing to unavailability of cost data for these economies, it was not possible to estimate a measure of relative costs. The internal real exchange rate, which has some of the advantages of a measure of relative costs, is calculated as the price ratio of nontradables to imports (the latter being a proxy for tradable goods).15

Both measures show that the real exchange rate depreciated sharply in 1994 and that it appreciated in the following three years, although a substantial margin of improvement remains relative to 1994. These results suggest that the devaluation of 1994, together with the accompanying policies, improved the competitive position of the region and that the competitiveness gains have been broadly maintained. The evolution of domestic costs and prices will nonetheless need to be carefully monitored to avoid a recurrence of the overvaluation of the early 1990s.

The results are more mixed before 1994. On average, the external real exchange rate shows no appreciation of the real exchange rate before the devaluation of the nominal exchange rate in 1994. In contrast, the internal real exchange rate shows a significant appreciation before 1994, tending to confirm the theoretical presumption that the internal real exchange rate is a superior measure for these economies.

Measuring the Real Exchange Rate

The external real exchange rate (RERX) is calculated here as the ratio of consumer price indices:

RERX=CPId/(CPIfE¯),   

where CPId and CPlf are the domestic and foreign consumer price indices, respectively, and Ē is the nominal exchange rate expressed in CFA francs per unit of foreign currency. An increase of the ratio implies an appreciation of the real exchange rate. Both CPlf and Ē are weighted averages for major trading partners, with bilateral trade shares used as the weights. RERX index is calculated for each of the seven economies of the WAEMU, and the national indices are then used to calculate a GDP-weighted average RERX for the WAEMU region (which is the one reported here). Box 5 shows the weights (GDP-weighted averages for the WAEMU) for the foreign price index in the calculations of the RERX.

The internal real exchange rate (RERN) is the ratio of nontradable to tradable goods prices. When the price of nontradable goods increases in relation to the price of tradable goods, factors of production move to the nontradables sector. To avoid such a reallocation of resources, a devaluation of the nominal exchange rate or a tightening of aggregate demand may be necessary. This is often the case when economic agents perceive as permanent a temporary resource “boom” in an economy that exports primary products.

The difficulty in measuring the internal real exchange rate is that there is no operationally straightforward definition of tradable and nontradable goods. As a result, the literature uses a variety of approximations.16 In the measure calculated here, the price of imports (Pm) is used for the price of tradable goods. An alternative would be to use the price of exports, but for economies with undiversified exports, the import price index is more representative of tradable goods prices.17

Weights for Calculating the External Real Exchange Rate

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Source: IMF, International Financial Statistics (IFS) (Washington), various issue DP-weighted averages for the WAEMU, calculated on the basis of trade shares during 1988–91.

The price of nontradables (Pn) is calculated on the basis of the domestic CPI, which is actually a weighted average of prices of tradable and nontradable goods. If these weights are known, it is easy to calculate the internal real exchange rate from the ratio of the CPI to the import price index (both expressed in terms of the domestic currency). Alternatively, it can be assumed that the weight of tradable goods in the CPI is equal to the average share of imports over total consumption—in line with the assumption that the import price is the price of tradable goods. The ratio of the CPI to the import price index can then be written

CPI/Pm=(PmyPn1-y)/(Pm)=(Pn/Pm)1-y=(RERN)1-y

wherey is the weight of tradable goods in the CPI. Therefore,

RERN=(CPI/Pm)1/1-y.

Figure 1 shows the GDP-weighted average external real exchange rate (ratio of domestic to foreign CPIs) for the WAEMU economies. The real exchange rate appreciated during most of the 1970s before depreciating between 1979 and 1984. It then appreciated between 1984 and 1986 without, however, reaching its 1979 level. It depreciated gradually during 1986–93 and sharply in 1994, but appreciated in the following years, partially offsetting the effect of the nominal exchange rate devaluation in 1994.

The internal real exchange rate in Figure 1 shows a substantial appreciation between 1985 and 1994, reversing the depreciation that occurred between 1980 and 1985. It reached its highest level in 1993, just before the devaluation. Finally, the devaluation of 1994 caused the internal real exchange rate to depreciate substantially in that year, although this effect was offset to some extent in the following years.

In addition to the effect of the devaluation of the CFA franc against the French franc in 1994, the real exchange rate of the WAEMU may also be influenced by the movement of the U.S. dollar against the French franc (Figure 2). The nominal exchange rate of the WAEMU in terms of the U.S. dollar (which reflects both factors) appreciated from 1985 to 1994. The two measures of the real exchange rate for the WAEMU show similar movements, although the internal real exchange rate exhibits fluctuations that are amplified by domestic price movements.

Conclusions

This appendix constructed two measures of the real exchange rate in the WAEMU for the period 1970–97.

The external real exchange rate shows on average no appreciation of the real exchange rate before the devaluation of the nominal exchange rate in 1994, while the internal real exchange rate—which is thought to provide a better measure of competitiveness—shows a significant appreciation of the real exchange rate before 1994, as does the nominal exchange rate visà-vis the U.S. dollar. Both measures of the real exchange rate depreciated sharply in 1994 and appreciated somewhat thereafter, although the competitiveness gains achieved in 1994 have been largely preserved.

Appendix III Determinants of Investment in the WAEMU

Capital investment, by increasing productive capacity and serving as a vehicle for new technologies, is an important engine of growth. It is thus encouraging that the share of investment in GDP has risen in every country of the WAEMU in recent years. However, the fact that the average investment ratio remains low in the WAEMU, compared not only with the developing countries of Asia, but also with the rest of sub-Saharan Africa, remains a source of concern (Table 3). Investment ratios vary widely within the WAEMU, from relatively high ratios in Burkina Faso and Mali to very low ones in Côte ďlvoire, Togo, and, especially, Niger (Appendix IV, Table 10). The empirical tests presented in this appendix seek to explain these differences by using panel regressions to examine the determinants of annual investment (private plus public) in the period 1970–95 for die seven WAEMU countries for which data were available.

Table 3.

Investment Share, Trade Share, and Index of Economic Freedom in the WAEMU and Other Selected Countries, 1995

(Percent)

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Sources: IMF, World Economic Outlook database;World Bank, World Development Indicators database; and J. Gwartney, R. Lawson, and W. Block, Economic Freedom of the World (1996).

Unweighted average of freedom of capital transactions and freedom of business to compete, for most recent year. A value of 0 is the least free, one of 10 is the most

Excluding Guinea-Bissau.

Central African Republic, Chad, and Nigeria.

Several factors have been suggested as explaining investment behavior.18 The traditional accelerator model suggests that changes in income should be positively associated with short–run fluctuations in investment. Other explanations of a more structural nature include demographic trends, the competitiveness and profitability of exports, and the attractiveness of the business environment. While difficult to measure, attractiveness of the business environment probably includes freedom from bureaucratic meddling and excessive regulation, as well as openness to the outside world through access to foreign goods and capital. Indeed, one of the advantages suggested for regional (and global) integration is that it may increase investment and hence growth. A related factor is the international competitiveness of domestic producers. The WAEMU countries experienced an appreciation of the real exchange rate in the late 1980s and early 1990s, which was associated with low investment, but investment rebounded after the devaluation of 1994. Finally, the price and profitability of the regionďs exports—which consist largely of primary commodities—could be expected to influence domestic investment. This relationship might be captured through the price ratio of primary commodities to manufactures.

The results of the panel regressions, using the average investment share of the WAEMU (1NV) as the dependent variable during 1970–95, tend to confirm most of the hypotheses mentioned above. The growth variable (GROW) is not statistically significant (despite being biased upward, since positive investment probably also increases contemporaneous growth to some extent). However, the dependency ratio (DEP)—the ratio of the young and the elderly to those of working age; a measure of openness (OPEN)—exports plus imports divided by GDP; and two indices of “economic freedom” are significant. The economic freedom variables are subjective indicators 19 that measure the freedom of businesses to compete domestically (COMPETE) and the freedom of international capital transactions (CAPITAL). A simple average of the two variables for 1995 is reported in Table 3. In addition, the real effective exchange rate (RER,) which is based on relative GDP deflators, has a significant negative effect on investment.20 The regression did not include country dummies, and thus differences between countries that are not captured by the explanatory variables show up in the random error terms:

INV=0.104OPEN+0.101GROWTH(3.15)(1.36)-46.9DEP+5.49COMPETE(3.64)(3.31)+3.98CAPITAL-0.172RER(4.64)(4.82)

Number of observations = 152 R2= 0.37

t–statistics are reported in parentheses below the coefficients.

Additional explanatory variables were tried and some of those mentioned above were dropped, but generally the variables included remained statistically significant,21 A Granger causality test was run, which confirmed that openness influenced investment rather than the reverse. The measure of openness is imperfect because larger countries tend to have lower ratios of trade to GDP than smaller ones for a given level of trade restrictiveness; inclusion of country size (as measured by GDP) in the regression still yielded a significant coefficient for the openness variable. Thus, there seems to be firm evidence that more freedom to compete and to access foreign goods and capital markets has favorable effects on the scale of investment in WAEMU countries, adding to evidence for other regions.22

Appendix IV Background Tables

Table 4.

WAEMU: Output Growth

(Annual percentage changes)

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Sources: IMF staff estimates, and World Economic Outlook database, January 1998.

Excluding Guinea-Bissau.

Table 5

WAEMU: Trade Volume Growh

(Annual percentage changes)

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Sources: IMF staff estimates, and World Economic Outlook database, January 1998.

Excluding Guinea-Bissau.

Table 6

WAEMU: Real Effective Exchange Rates

(Annual percentage changes)

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Sources: IMF staff estimates.Note: In terms of relative consumer price indices.

Excluding Guinea-Bissau.

Table 7

WAEMU: Inflation

(Annual percentage changes)

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Sources: IMF staff estimates, and World Economic Outlook database, January 1998.

Excluding Guinea-Bissau.

Table 8

WAEMU: Fiscal Balances

(Percent of GDP)

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Sources: IMF staff estimates, and World Economic Outlook database, January 1998.

Excluding Guinea-Bissau.

Table 9

WAEMU: Government Revenue, Excluding Grants

(Percent of GDP)

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Sources: IMF staff estimates, and World Economic Outlook database, January 1998.

Excluding Guinea-Bissau.

Table 10.

WAEMU: Gross Domestic Investment

(Percent of GDP)

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Sources: IMF staff estimates, and World Economic Outlook database, January 1998.

Excluding Guinea-Bissau.

Table 11

WAEMU: Gross Domestic Saving

(Percent of GDP)

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Sources: IMF staff estimates, and World Economic Outlook database, January 1998.

Excluding Guinea-Bissau.

Table 12

WAEMU: External Current Account Balance, Excluding Grants

(Percent of GDP)

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Sources: IMF staff estimates, and World Economic Outlook database, January 1998.

Excluding Guinea-Bissau.

Table 13.

WAEMU: Public External Debt

(Percent of GDP)

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Sources: IMF staff estimates, and World Economic Outlook database, January 1998.

Excluding Guinea-Bissau.

Table 14.

WAEMU: Balance of Payments

(Billions of CFA francs)

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Source: BCEAO.Note: Data are provided by the BCEAO and may show differences with data from the World Economic Outlook database

Excluding official transfers.

Table 15.

WAEMU Governments’Financial Operations

(Billions of CFA francs)

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Source: BCEAO.Note: Data are provided by the BCEAO and may show differences with data from the World Economic Outlook database

Total revenue less total expenditure excluding interest due, externally financed investment, and net lending

Table 16.

WAEMU: Monetary Survey

(Billions of CFA francs)

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Source: BCEAO.

Includes data for liquidated banks.

Table 17

WAEMU: Summary Accounts of the Central Bank

(Billions ofCFA francs)

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Source: BCEAO.

Includes data for liquidated banks.

Includes liabilities to IMF.

Table 18.

WAEMU: Summary Accounts of the Commercial Banks

(Billions of CFA francs)

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Source: BCEAO.

Includes data for liquidated banks

Excluding all intra-WAEMU claims and liabilities, including securitized debt of governments

Including deposits with central bank, currency in vaults, and BCEAO short-term bonds.

Table 19.

WAEMU: Indicators of Banking Sector Soundness

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Source: WAEMU, Annual Report of the Banking Commission (1996).

In percent of credit to the economy, unless otherwise indicated

Total amount of bad loans (that is, including provisions) over total credit.

Table 20.

WAEMU: Convergence Criteria

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Sources: IMF staff estimates; and WAEMU regional Banking Commission.