For the past year, a debate has raged over the role and impact of the CFA franc in West Africa. Supporters of the controversial exchange rate arrangement argue that the peg to the Euro has delivered a credible and stable currency while keeping inflation low. Critics, however, contend that the loss of monetary policy independence (and lack of control over foreign exchange reserves) has stifled economic growth. Some commentators have questioned the sustainability of the CFA franc zone on both economic and political grounds.
What are the stakes in Eastern Africa? Countries in the region have adopted a wide range of exchange rate regimes: from a currency board in Djibouti to a free-float in Somalia. Only Comoros has a regime similar to the CFA franc zone, with the French government guaranteeing the free convertibility of the Comorian franc and its peg to the Euro. Although the Eastern Africa region has experienced strong economic growth as a whole - with an average GDP growth rate of 6.5% since 2011 - the performance has been uneven. Growth has been subdued in some countries since 2015 and exchange rate movements have been more volatile.
At the 21st session of the Intergovernmental Committee of Experts, which recently took place in Comoros, experts from Eastern Africa shared experiences on the choice of exchange rate regimes and its impact on economic performance. Some of the evidence presented suggested a potential trade-off: fixed regimes seem to be associated with lower inflation and economic growth, while intermediate regimes - whereby the central bank actively intervenes in the foreign exchange market to influence the value of the currency - appear to be associated with higher economic growth and inflation.[1] Experts agreed that there is no one-size-fits-all prescription for the region, with the optimal choice depending on each country's circumstances and challenges. Hence, countries should regularly monitor the effectiveness of their exchange rate policy and reassess the suitability of other regimes. Nonetheless, policy changes (if required) must be implemented in a gradual fashion. South Sudan, for instance, suffered a very sharp depreciation of its currency when it moved suddenly from a fixed regime to a floating regime in 2015.
Dr. Cheik Hamidou, Head of the Economic Analysis Department of the Central Bank of Comoros, argued that a fixed exchange rate helps to secure macroeconomic stability and control the cost of imports, on which the small island developing state is heavily dependent. Conversely, a floating exchange rate allows Madagascar to enhance the competitiveness of its exports (namely, textiles, vanilla and ores), according to Mr. André Andriamiharisoa, Director of Studies of the Central Bank of Madagascar. In the case of Rwanda, the Central Bank has put in place mechanisms to manage the exchange rate and stem excessive currency volatility. Nonetheless, the choice of exchange rate regime must be complemented by other policies to fully realise its potential. For instance, an undervalued (competitive) exchange rate can only boost exports if the economy has adequate productive capacities to fulfil those opportunities. Dr. Pedro Martins, an economist at ECA in Eastern Africa, also pointed out that economic diversification is crucial for tackling depreciation trends and improving economic resilience.
In the meeting, there was also space to discuss the East African Monetary Union (EAMU), which is planned for 2024. The establishment of a monetary union is expected to promote trade and investment within the East African Community (EAC). Professor Thomas Kigabo, Chief Economist at the Central Bank of Rwanda, presented a report (see draft) assessing the level of macroeconomic convergence in the EAC. According to him, there is still some way to go to meet the EAMU convergence criteria, especially regarding budget deficits and foreign exchange reserves.[2] While there has been some convergence of inflation and exchange rates, GDP growth rates differ significantly and regional trade remains weak. Professor Kigabo argued that there is an urgent need to improve policy coordination, deepen economic integration, and fast-track the establishment of vital institutions - such as the East African Monetary Institute - prior to the formation of the monetary union. Recent studies show that the advantages of adopting a common currency only outweigh its disadvantages if countries belong to an optimal currency area - i.e. if they are sufficiently integrated and their economies respond to external shocks in a similar way.
Experience sharing among East African countries has helped come to the realisation that the appropriate exchange rates policies are essential to foster growth and development. Likewise, the future East African single currency will help development only if East African countries are able to strengthen their degree of economic integration.
[1] For further details, see the concept note of the ad hoc expert meeting (AEGM).
[2] There are four main convergence criteria: overall inflation ceiling of 8%, budget deficit (including grants) ceiling of 3% of GDP, public debt ceiling of 50% of GDP in present value terms, and foreign exchange reserves of (at least) 4.5 months of imports.
