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Tuesday, August 4, 2020

The ECO, the proposed new currency for West Africa: Is Ecowas technically ready for the sea change?

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By Suwareh Darbo

Introduction
The single currency comprising 15 member states of Ecowas was initially planned to be introduced in 2003. It will be based on a flexible exchangerate and backed by a central bank. This isn’t the first shared currency in post-colonial Africa. The CFA franc is now used by about 150 million people in 14 African countries, most of which are former French colonies. Unlike the CFA franc currently pegged to the Euro, which reduces the autonomy of national central banks to conduct monetary policy, the Eco is expected to be managed by a single central bank with the capacity to make monetary-policy decisions under an inflation-targeting regime.

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There is no single monetary union encompassing all CFA franc users. Instead, there are two different currencies that go under the same name: the West African CFA franc and the Central African CFA franc. By comparison, the Eco will be the single currency of 15 countries, bringing together 380 million citizens under a common monetary framework. Finally, and most importantly, the new monetary union will include the largest economy in Africa, Nigeria.

The launch has been postponed several times in 2005, 2010 and 2014 owing to the difficulty in meeting the four primary criteria to be achieved by each member country:
I) A single-digit inflation rate at the end of each year;
ii) A fiscal deficit of no more than 4% of the GDP;
iii) A central bank deficit-financing of no more than 10% of the previous year’s tax revenues; and,
iv) Gross external reserves that can give import cover for a minimum of three months.
The six secondary criteria to be achieved by each member country include:
I) Prohibition of new domestic default payments and liquidation of existing ones;
ii) Tax revenue should be equal to or greater than 20 percent of the GDP;
iii) Wage bill to tax revenue equal to or less than 35 percent;
iv) Public investment to tax revenue equal to or greater than 20 percent;
v) A stable real exchange rate; and,
vi) A positive real interest rate.
These criteria are due to be assessed by Ecowas by the end of 2019. One of the problems is inconsistency: A country could, for example, meet the criteria this year, but falls behind next year.So far, not one Ecowas country has consistently met all the criteria. For starters, only five (Cape Verde, Ivory Coast, Guinea, Senegal and Togo) of the region’s fifteen countries currently meet the single currency’s criteria of a budget deficit not higher than 4% and inflation rates of not more than 5%. In 2016, only one country, Liberia, met all the six conditions (four primary criteria and two secondary criteria), and no single criterion was met by all the countries. According to the African Development Bank, regional inflation has stood at double digits since 2015, way above the five percent target outlined as one of the convergence criteria for Eco’s implementation.

Meanwhile, Nigeria which controls two-thirds of the regional economy, has struggled to meet its growth projections.In order not to stall the process, it is being suggested that countries that are ready will launch the single currency while those not ready will join the program upon meeting the requisite criteria.

Potential tailwinds/opportunities
Conventional economic theory suggests that a single currency can reduce transaction costs, promote cross border trade, boost growth and economic development in general. The member countries can exploit their comparative advantage by specialising in the production of goods they produce efficiently. Cross border trade can also enhance economies of scale, promote thegrowth of SMEs, strengthen backwardand forwardlinkagesbetween SMEs and large enterprises thus, giving an impetus to industrialization. It is estimated that trade between Eurozone countries increased by between 5 and 20 per cent after the introduction of the Euro.Additionally, a single currency obviates the need to resort to continuous currency devaluations in order to enhance external competitiveness. Instead, countries seek to improve the business environment and enhance productivity.

Some economists also argue that a single currency can respond more effectively to exogenous shocks orchestrated by external policieswithout worrying about exchange rate costs. In other words, the members can put up a collective and efficient front against exogenous shocks.

As experienced by the Eurozone countries, a shared currency led by an autonomous central bank tends to keep inflation under control. For example, in the twenty years prior to joining the Euro, Spain’s inflation rate averaged 8.5 per cent as opposed to 2 per cent between 1999 and 2018.

Potential headwinds/challenges
As the Euro experience has demonstrated, a single currency has some significant shortcomings. Somemembers take advantage of their membership in the Euro zone, an economic giantwith a share of 16.3% in the global economy (purchasing power parity), to take on debt at low financing costs thus increasing their fiscal deficits and public debt. A case in point is Greek and Spain debt crisis which almost threatened the integrity of the Euro. The Euro almost collapsed under the weight of this debt crisis. While some Euro-Zone countries have the financial muscle to bail out Greece and other debt distressed countries, given the limited fiscal space, regional economies (Ecowas member states) are not strong enough to back bailouts in the event of a crisis among participating member states.

In addition, a monetary union has short-term costs. Countries willing to join the Eco must meet some convergence criteria aimed at maintaining macroeconomic stability. These criteria which have been spelt out in the Introduction aren’t very different from those contained in the Maastricht Treaty.Unfortunately, no Ecowas country has been able to fulfill all criteria in recent years, which suggests that the 2020 deadline might have to be postponed once again. It is no surprise that those Ecowas economies that currently share a common currency (the CFA franc) already meet most of these requirements, whereas countries with monetary sovereignty have struggled to get their house in order.

There is also the “Nigerian factor”, the region’s biggest economy constituting two-thirds of its GDP. Skeptics argue that the Eco isn’t a single currency for 15 countries; instead, it is the Nigerian Naira plus a few countries. There are, therefore, apprehensions that Nigeria will dominate monetary policy and erode the potential benefits. In this regard, one may compare the “Nigerian factor” with Germany’s dominance in the Eurozone, questioning whether sometimes diverse economies with varying levels of development can successfully share the same currency. The Gambia, for example, has a GDP of about $1.480 billion, while Nigeria has a GDP of USD376 billion (2017), the former constituting only 0.4% of the latter. It should, however, be recalled that in any such arrangement, the biggest economy tends to dominate. For example, in SADC, South African, which is the biggest economy dictates terms. At this moment, we can only hope that Nigeria will not be a bully and will play its dominant role positively.

Sceptics also point to the lack of integration policies among member countries in the region.In addition, they point to inadequate supply chain infrastructure, tariffs and non-tariff barriers, unbridled corruption and widespread insecurity.
There are other hurdles, including the formidable challenge for francophone countries in Ecowasto dispense with an existing single currency.Eight of Ecowas member states already use the France-backed West African CFA franc. As part of a long-standing monetary agreement, these countries deposit half of their foreign reserves with the French treasury.

It may not be easy to disengage from or abandon this long standing arrangement in favour of the Eco, especially given the benefits of lower interest rates and currency stability which has been driving investment and growth in some of these countries. These benefits come from a stable currency guaranteed by France. It may not make economic sense to align one’s currencies with less stable ones and much higher levels of inflation and interest rates, notwithstanding the appeal and overwhelming desire to severe colonial links and embrace the Eco as an African initiative.

Anecdotal evidence
During my attachment at the IMF in 2006/2007, I wrote a paper entitled “Trade and Regional Integration in Ecowas: Is Ecowas Trade Diverting or Trade Creating”. The objective of the analysis was to investigate whether Ecowas has promoted trade within its members states with a view to determiningthe effectiveness of the trade agreement using the Gravity model.

The investigation revealed the following:
I) The Gravity Model has been able to explain trade within Ecowas. The elasticities of GDP, population and distance have the expected signs and are significant.
ii) The Ecowasdummy variable is positive suggesting that Ecowas is trade creating, However, the coefficient has been declining reflecting the downward trend in trade intensity within the community. It confirms that the trade promoting effect of Ecowas is declining overtime. The decline in trade intensity within the community is due to, among other factors, the increase in transaction costs arising essentially from administrative bottlenecks and poor transport and communication infrastructure, and not because Ecowas member states are essentially primary commodity producers.
iii) The results confirm that countries in the CFA zone have had a negative impact on their trade which Subramanian and Tamirisa (2000) attributed to exchange rate misalignment within the CFA zone, represented here as UEMOA.
iv) Cultural proximity as captured by the use of a common language is a strong trade creating factor. Presumably, common language reduces transaction costs thus fostering trade.
v) Sharing a common border has also had a positive impact on trade confirming that countries which share a common border tend to trade more with each other
Ecowas member states are now trading more with Asia and less among themselves and with traditional trading partners like Europe. For most of the periods, the coefficients for the Asian dummy is more significant than the European and North American dummies. The results debunk the “marginalisation from trade hypothesis” which argues that Africa has not benefited from globalisation because it has not globalised in the first place. At least in the case of Ecowas, the available evidence suggests the contrary.

The main recommendation emanating from the study is that the authorities in Ecowas should intensify efforts at improving transport and communication infrastructure (multinational road projects), implement the protocols of free movement of goods and services to the letter, minimise bureaucracy and remove administrative bottlenecks in trade transactions. Policies such as export diversification and aid for trade will also help boost trade, integration and economic growth. As observed by the World Bank (1989) trade within Ecowas member states has been limited due to poor transport and communication infrastructure and the existence of tariff and non-tariff barriers all of which increase transaction costs.

Conclusion
The common currency is not an end in itself. It will not necessarily make doing business any easier than it is now. However, the introduction of the Eco will certainly give a pod to the creation of a customs union and a free trade area while at the same time facilitating the realisation of the objectives of the African Free Trade Area.
To my mind, Ecowas should proceed and introduce the Eco in 2000 on account of the following reasons:
i) It is impossible for all the countries to meet the convergence criteria at the same time. Countries which meet the criteria now should proceed while the others follow once they meet the criteria;
ii) The Nigerian factor is being overplayed. Ecowas member states should take a cue from the Euro Zone where Germany is the dominant player. Germany hasplayed a pivotal role in rescuing the Euro in the wake of thedebt crisis. Nigeria can play a similarrolein the event of a crisis, given its financial muscle. It will be a great sense of pride for Nigeria toplay such a role;
iii) Thereis a tremendous amount of political willwhich will contribute to the Eco’s success. There is every indication that the Ecowas heads of state want to proceed head on with this project which has been stalled for a very long time;
iv) In the spirit of Pan-Africanism, theCFA zone countries in Ecowas will willingness give up their membership in favour of the Eco, unless of coursethecosts are exorbitant to bear;
v) While issues relating to poor infrastructure, bureaucracy,red tape and security are all genuine concerns, it should not deter the authorities toproceed. It is inconceivable and impossible to address all the challenges prior to moving on; and,
vi) Varying sizes of the economies of Ecowas should not constitute a deterrent to the introduction of the Eco. The Euro zone comprises economies of various sizes with Germany and France at the end of one spectrum having a GDP of USD 4029 billion and USD 2795 billion respectively and Cyprus and Malta at the end of the other spectrum having a GDP of USD 24 billion and USD 14 billion respectively.

Recommendations
I) Improve the implementation of existing Ecowas trading agreements, including liberalisation of regional trade, the consolidation of the customs union and the creation of a free trade area;
ii) Improve the physical infrastructure;
iii) Reduce bureaucracy and red tape in the borders;
iv) Focus on diversification and value addition as a hedge against external shocks and price volatility; and,
v) Implement structural reforms aimed at strengthening political and economic institutions, attracting foreign investments, and creating a business-friendly environment forthe private sector.
As an optimist and a member of Ecowas, I hope for the best and wish the Eco good luck.
Suwareh Darbo was born in Dumbutu, Kiang West in 1963. He began his professional career in the Ministry of Finance in 1988 where he served until 1995 before joining the United Nations Development Programme in The Gambia as national economist. He joined the African Development Bank in 2004 and is currently serving as principal country economist for Lesotho based in Pretoria, South Africa

Disclaimer: The views expressed here are those of the writer and do not necessarily reflect the views of the African Development Bank.

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