Benin: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
24 Nov 2004
eISBN:
9781451962284
Language:
English
Keywords:
ISCR; CR; Benin; right; price; exchange rate; Benin's real effective exchange rate; CFA franc; currency Benin effects; Benin's factor costs; equilibrium exchange rate; Exchange rates; Transportation
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This Selected Issues paper and Statistical Appendix analyzes sources of economic growth in Benin. It concludes that the policies implemented since the early 1990s paved the way for higher growth rate by raising total factor productivity as well as capital accumulation. The paper examines the cotton sector reform in Benin and the subsidies by major producing countries. It also analyzes recent trends in Benin’s external competitiveness, and conducts an analysis of the equilibrium exchange rate to assess whether the movements in the real effective exchange rate in Benin were consistent with the underlying macroeconomic fundamentals.

Abstract

This Selected Issues paper and Statistical Appendix analyzes sources of economic growth in Benin. It concludes that the policies implemented since the early 1990s paved the way for higher growth rate by raising total factor productivity as well as capital accumulation. The paper examines the cotton sector reform in Benin and the subsidies by major producing countries. It also analyzes recent trends in Benin’s external competitiveness, and conducts an analysis of the equilibrium exchange rate to assess whether the movements in the real effective exchange rate in Benin were consistent with the underlying macroeconomic fundamentals.

IV. Developments in the External competitiveness of Benin31

50. This chapter analyses recent trends in Benin’s external competitiveness based, on internal and external real exchange rates and other indicators (factor costs and business environment). It also conducts a preliminary analysis of the equilibrium exchange rate, to assess whether the movements in the real effective exchange rate in Benin were consistent with the underlying macroeconomic fundamentals.

A. Evolution of Real Exchange Rates

Real effective exchange rate

51. The evolution of Benin’s real effective exchange rate (REER) in the aftermath of the January 1994 devaluation can be divided into three phases (Figure IV.1): (i) during 1994 and 1995, the REER appreciated (rapidly during 1994, followed by a slower pace in 1995), driven by the surge in domestic wages and prices; (ii) during the period 1996-2000, inflationary pressures were contained, contributing to a stable real effective exchange rate, the slight upward trend in the relative prices being offset by an opposite trend in the nominal exchange rate; and (iii) since 2001, the REER has been appreciating, mainly reflecting the strengthening of the euro against the U.S. dollar.

Figure IV.1.
Figure IV.1.

Benin: Effective Exchange Rates, January 1993-April 2004

(Index 1990 = 100)

Citation: IMF Staff Country Reports 2004, 370; 10.5089/9781451962284.002.A004

Source: IMF, Information Notice System (INS); and staff estimates.

Benin: Average Annual Change in Real Effective Exchange Rate and its Components

(In percent)

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Sources: IMF, Information Notice System; and Fund staff calculations.

52. With the recent appreciation of the REER, at end-2003, Benin had preserved about 25 percent of the external competitive gains from the devaluation of the CFA franc in 2004. Among the countries of the West African Economic and Monetary Union (WAEMU), Benin had the highest appreciation of the REER since the 1994 devaluation (Figure 2). This stemmed from the higher inflation rates in Benin until 2000, compared to its peers in WAEMU (Figure IV.3).

Figure IV.2.
Figure IV.2.

Real Effective Exchange Rates for Selected WAEMU Countries

(Index, 1994 = 100)

Citation: IMF Staff Country Reports 2004, 370; 10.5089/9781451962284.002.A004

Figure IV.3.
Figure IV.3.

Benin Price Index (CPI) Relative to Selected WAEMU Countries

(Index, 1994 = 100)

Citation: IMF Staff Country Reports 2004, 370; 10.5089/9781451962284.002.A004

53. The bilateral real exchange rates with France and the United States, the two countries with whose currency Benin effects most of its trade, shed an interesting light on the evolution of the exchange rate (Figure IV.4).32

  • Following the devaluation in 1994, there was a continuous real appreciation vis-à-vis France through 2001—some 30 percent cumulatively, half of which after 1995—as inflation in Benin remained higher than that in France throughout this period, although the CFA franc was pegged to the French currency (the French franc until 2000; the euro since then).33

  • The bilateral real exchange rate with the U.S. was driven by the movements of the parity between the French franc (euro) and the U.S. dollar, as their relative price index remained largely stable after 1996: the real depreciation vis-à-vis the U.S. during the second half of the 1990s reflected the depreciation of the French franc against the U.S. dollar, the real appreciation since 2001 reflected the appreciation of the euro.

Figure IV.4.
Figure IV.4.

Benin: Bilateral Real Exchange Rates (RER) with France and the U.S.A.

(Index, 1994 = 100)

Citation: IMF Staff Country Reports 2004, 370; 10.5089/9781451962284.002.A004

Internal real exchange rates

54. The movements in the internal real exchange rates (IRER—the ratio of the prices of nontraded goods to those of tradable goods) shows Benin’s inability to reduce the high cost of production to export (Figure IV.5).34 In particular, there was a steady real appreciation from the devaluation in 1994 through 1999, attributable to larger increases in the prices of non-traded goods (than in the prices of tradable goods), which burdened the profit of the tradable sector, and thereby hampered the much-needed export diversification of the economy.

Figure IV.5.
Figure IV.5.

Benin: Internal Real Exchange Rate

(Index, 1994 = 100)

Citation: IMF Staff Country Reports 2004, 370; 10.5089/9781451962284.002.A004

B. Estimating the Equilibrium Real Exchange Rate

55. In this section, we use the fundamentals approach to the exchange rate to assess whether the movements in the real effective exchange rate in Benin were consistent with the underlying macroeconomic fundamentals.35 We first estimate the long-run relationship between the effective real exchange rate and its fundamentals, using the cointegration techniques. Subsequently, we calculate the path of equilibrium real exchange rates using the estimated parameters and nontransitory components of the determining fundamentals.

56. Following Edwards’ model (1989 and 1994),36 we include the following variables as the set of fundamentals underlying the equilibrium real exchange rate:37 the terms of trade, government demand for nontradables, fiscal deficit, capital inflows, and technological progress. The terms of trade drive the real exchange rate through both income and substitution effects, and their net effect is theoretically ambiguous. Regarding government demand for nontradables, we use the ratio of government spending to GDP as a proxy. The expected sign for this variable is ambiguous in the absence of a breakdown of government spending in tradable and nontradable goods (see for example Montiel, (1999). Regarding fiscal deficit, its increase is expected to appreciate the long-run equilibrium exchange rate through its potential positive impact on domestic prices. Capital inflows would lead to an appreciation of the real exchange rates by their positive effect on the demand for the nontradables. Technological progress is included in the fundamentals to capture the Balassa-Samuelson effect. We use real GDP growth as a proxy for this variable, in the absence of a better measure for the differential in productivity growth between traded and nontraded good sectors.38 A positive sign is expected for this proxy as a higher real GDP growth rate could be an indication of a differential in productivity growth in favor of the traded good sector.

57. For the cointegration analysis, each variable has been tested for unit roots. The data set and the results of the unit root tests are presented in Appendix II, along with the results of the Johansen cointegration tests. The estimation results should be interpreted with caution due to data quality problems and the existence of more than one cointegrating equations. The equation presented in Table IV.3 provides the best statistical fit.39

Results of Cointegration Estimations1/

Dependent Variable: Real Effective Exchange Rate

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Standard errors are in parentheses.

denotes significance at the 1 percent level.

58. The terms of trade have a positive and significant sign, indicating that their improvement would result in an appreciation of the long-run equilibrium real exchange rate. Government consumption has an unexpected and significant negative coefficient. This could result from the nondistinction between expenditures on tradable and nontradable goods; similar results have already been reported by other empirical studies.40 The budget deficit and capital inflow variables have each a positive and significant sign, as expected. Finally, the coefficient for technological progress is negative and significant. This is in contrast to the theoretical expectation based on the Balassa-Samuelson effect and to other empirical studies.41

59. Based on the results of the cointegration regression, the equilibrium real exchange rate was computed using the long term components of the fundamentals.42 Figure IV.6 displays the evolution of the actual and the estimated equilibrium real exchange rate for 1990-2003. It shows that:

  • the actual REER was well above its equilibrium level during 1990-94, suggesting that the 1994 devaluation was warranted;

  • the gap between the actual REER and its equilibrium level narrowed in the years following the devaluation, and the REER was hovering around its equilibrium level during 1996-2001;43 and

  • since 2002, the real effective exchange rate would be above its estimated long-term equilibrium level.

Figure IV.6.
Figure IV.6.

Benin: Actual and Estimated Equilibrium Real Effective Exchange Rates (REER) 1/

(Index for both series 2/

Citation: IMF Staff Country Reports 2004, 370; 10.5089/9781451962284.002.A004

1/ See text for estimation of equilibrium REER.2/ For the actual REER, 1994=100

These results, however, should be viewed as preliminary and indicative only, given the weakness in the data.

C. Other Competitiveness Indicators

60. Despite the higher appreciation of its REER since 1994, overall, Benin’s factor costs do not appear to be higher than in other WAEMU countries, based on available indicators and subject to data quality issues (Table IV.1). Labor, electricity, and transportation costs in Benin appear to be similar to those in other WAEMU countries; however, there are areas, such as telecommunications and construction, where Benin is at a clear cost disadvantage. In other areas, such as petroleum products and water, Benin seems to have a relative cost advantage.

Table IV.1.

Benin: Factor Costs in Different WAEMU Countries, 2002

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Source: Senegal: Integrated Framework Diagnostic Trade Integration Study, World Bank (2002)

In percent.

Local calls, fixed line.

Gasoline, super grade.

Local transport.

To France.

61. Recent trends in factor costs, however—notably public sector wages—are a cause for concern. Average public sector wages increased by 7.6 percent per annum during the period 1997-2003 (Table IV.2). As salary increases in the public sector are generally replicated in the private sector with a lag, this trend may weigh on the competitiveness of the private sector. Also, the costs of transportation and water appear to have increased significantly during the same period. While there was no increase in the price of telecommunications, these remain the highest in the region.

Table IV.2.

Benin: Evolution of Factor Costs, 1997-2003

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Sources: BCEAO; and Fund staff calculations.

Nominal rate of growth adjusted by the growth in the nominal effective exchange rate.

Includes wages and benefits.

Medium voltage.

62. Based on the data for the crop-year 2000/01, Benin has a cost advantage, relative to many of the world major cotton producers (Table IV.3), especially in the agricultural production phase (ginning costs are above average). However, as high subsidies by major producing countries reduce the world market price sizably, Benin cannot fully benefit from this cost advantage.

Table IV.3.

Cotton Production Costs, 2000/01

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Source: Survey of the Cost of Production of Raw Cotton (September 2001), International Cotton Advisory Committee.

Country averages.

Cotton fiber.

63. The efficiency of the Port of Cotonou has been notoriously low. This has an important bearing on the overall competitiveness of the country as it is the single most important in- and outlet for Beninese imports and exports, providing transit services to the hinterland and coastal countries (mainly Nigeria). It has not been able to benefit from the recent drop of activity in the port of Abidjan, contrary to its competitors, the ports of Lome and Accra, reportedly because of higher costs and lower efficiency. The authorities have recently started to implement a plan to improve the management of the Port of Cotonou to make it more efficient and competitive; the resulting efficiency gains have resulted, in May 2004, in the reduction of the congestion surcharge paid by the Port of Cotonou—which, however, remains higher than that for the Port of Lome (Figure IV.7).

Figure IV.7.
Figure IV.7.

Europe-West Africa Trade Agreement (EWATA) Congestion Surcharges for Cotonou, Lome, and Lagos ports

Citation: IMF Staff Country Reports 2004, 370; 10.5089/9781451962284.002.A004

Source: EWATA

64. Available information on governance and business environment in Benin suggests that significant improvements in the business environment (regulatory quality, government effectiveness, rule of law, and control of corruption) are needed to strengthen competitiveness (Table IV.4). In these areas, Benin’s indicators, while broadly at par with sub-Saharan African average, remain far below those of successful African economies like Botswana and Mauritius, and newly developing Asian countries such as South Korea and Malaysia. However, Benin’s performance is strong regarding political stability and voice and accountability.

Table IV.4.

Governance and Business Environment Indicators for Selected Countries (2002) 1/

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Source: Kaufmann, Kraay, and Mastruzzi (2003).

The figures are based different surveys on each country standardized such that the average for all countries (198 in total) is zero for each indicator, which individually range between −2.50 and +2.50.

D. Conclusion

65. Measured by the real effective exchange rate, Benin’s export competitiveness has eroded in recent years, with the latest appreciation essentially reflecting the strengthening of the euro, to which the CFA franc is pegged. Competitiveness was also affected by the inability of Benin to reduce the high cost of production for exports. There is also some preliminary evidence that the real appreciation of the exchange rate would have brought it above its underlying equilibrium value.

66. In the circumstances, there is scope for strengthening competitiveness through the implementation of further structural reforms. Progress in civil service reform could help to maintain continued wage restraint. Further liberalization in the cotton sector could increase competitiveness in the ginning operations. In addition, the divestiture of public utilities, improving management of the Port of Cotonou, streamlining the regulatory framework, and strengthening the judicial system could all help to reduce the cost of doing business, and enhance efficiency. However, these reforms will unavoidably take time to produce results and should not therefore incur delays.

References

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  • Edwards, Sebastian, 1989, Real Exchange Rates, Devaluation and Adjustment: Exchange Rate Policy in Developing Countries (Cambridge: MIT Press).

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  • Hernandez-Cata and others, 1998, The West African Economic and Monetary Union, Recent Developments and Policy Issues, IMF Occasional Paper No 170 (Washington: International Monetary Fund).

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APPENDIX I: Internal Real Exchange Rate

The internal real exchange rate (IRER) is defined as the ratio of price of nontradable goods to that of tradable goods. As it is not straightforward to categorize the consumption bundle into tradable and nontradable goods, several proxies for the IRER have been used in the literature.44 Two different proxies were used in this study:

First proxy (IRER 1)

The calculation of this proxy follows Hernandez-Cata et al (1998) and is simply based on the definition of the consumer price index as a weighted average of prices of tradable and nontradable goods:

CPI=(PT)Θ(PNT)1−Θ(1)

where Θ is the share of tradable goods in the CPI basket.

Using the definition of IRER,

IRER=PNT/PT(2)

and reorganizing and substituting (1) in (2), the IRER can be expressed as

IRERl=(CPI/PT)1/(l−Θ)(3)

Import prices were used as a proxy for prices of tradable goods, and the share of imported consumption goods in total private consumption was used as a proxy for Θ.

The Second proxy (IRER2)

The second proxy was based on the three good model45 of Devarajan, Lewis and Robinson (1993). The model categorizes the economy as producing a domestic good and an exported good. Aggregate income is given by

PyY=PdD+PxX(5)

where Py, Pd and Px are the GDP deflator, the price of the domestically produced good and the price of the export good, respectively; and, Y, D, and X are total output, output of the domestically produced good, and the output of the exported good (all in real terms), respectively.

A straightforward rearrangement of (5) yields

Pd=(Py−SxPx)/(1−Sx)(6)

where Sx is the share of exports in real GDP.

The IRER can then be calculated using the standard definition, and using the import prices (Pm) as a proxy for the price of tradable goods:

IRER2=Pd/Pm(7)

APPANDIX II: Estimation of the Equilibrium Real Exchange Rate

Data set

The data set consists of 27 annual observations for each variable, covering the period 1977-2003. The data are taken from the IMF’s Economic Data Sharing System (EDSS).

Variables

LnREER: Natural log of real effective exchange rate (REER). REER is calculated by the IMF’s Information Notice System (INS) and based on the CPI. The GDP deflator was used to calculate the REER for the period before 1985, as the CPI series is not available for that period in the case of Benin.,.

LnTOT: Terms of trade in natural logs.

GOVCONS: Ratio of government consumption expenditure to GDP.

DEF: The ratio of overall budget deficit to GDP. CAPINFLO: The ratio of total grants to GDP.

TECHPROG: Real GDP growth (in natural logs) is used as a proxy for technological progress. The series was smoothened using Hodrick-Prescott filter.

Tests for stationarity of the series

The stationarity tests indicate that all series are I(1) The results of ADF tests are presented below.

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Critical values for the ADF test statistic (for a sample size of 27) is −3.64, −2.95, and −2.61 at 1, 5, and 10 percent levels respectively.

Johansen cointegration tests: The results of the maximum-Eigen value tests, presented below (intercept and no trend) suggest that there may be two cointegrating equations.

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denotes rejection of the hypothesis at the 1% level

Benin: Basic Data, 1996-2003

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Sources: Beninese authorities; and staff estimates.

STATISTICAL APPENDIX

Table 1.

Benin: Gross Domestic Product by Sector of Origin at Current Prices, 1996-2003

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Sources: Institut National de la Statistique et de l’Analyse Economique (INSAE); and staff estimates.
Table 2.

Benin: Gross Domestic Product by Sector of Origin at Constant 1985 Prices, 1996-2003

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Sources: Institut National de la Statistique et de l’Analyse Economique (INSAE); and staff estimates.
Table 3.

Benin: Supply and Use of Resources at Current Prices, 1996-2003

(In billions of CFA francs)

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Sources: Beninese authorities; and staff estimates.
Table 4.

Benin: Supply and Use of Resources at Current Prices, 1996-2003

(In percent of GDP)

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Sources: Beninese authorities; and staff estimates.
Table 5.

Benin: Production and Producer Prices of Cotton Products, 1995/96-2002/03

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Sources: Ministry of Rural Development, Department of Planning and Research; and Societe Nationale pour la Promotion Agricole (SONAPRA).