What does the future hold for the CFP franc? (Note)

Abstract:

· The CFP franc is the currency of the French Pacific territories (French Polynesia, New Caledonia, and Wallis and Futuna) and is pegged to the euro with unlimited convertibility guaranteed by the French Treasury.

· The adoption of the euro in these territories would facilitate trade with foreign countries and lead to a reduction in the cost of credit and access to the international capital market, which would encourage local and international investment;

· The planned transition to the euro in these Pacific territories requires a unilateral agreement, which has been delayed by the 2018 referendum on full sovereignty in New Caledonia.

The CFP franc[1] is the legal tender in French Polynesia, New Caledonia, and Wallis and Futuna. This currency was created after the end of World War II, by decree on December 26, 1945, during a devaluation of the French franc. Managed by the Overseas Issuing Institute (IEOM), the CFP franc has been linked to the French franc since 1949 and to the euro since January 1999 by a fixed but adjustable exchange rate, although it has never been devalued to date. The parity of the CFP franc with the euro is €1 for 119.33 CFP francs[2].

The transition to the euro is planned for these Pacific territories in the medium term.

Advantages and disadvantages of the CFP franc

After World War II, the status of the French colonial empire changed with, on the one hand, the departmentalization law of 1946, which changed the status of Guadeloupe, Martinique, Réunion, and French Guiana to French departments that had to comply with the laws and decrees of metropolitan France. On the other hand, the French colonies in the Pacific became « Overseas Territories » with their own currency created by the French government, the French Pacific Colonies franc (CFP franc), created at the same time as the French African Colonies franc (CFA franc). The creation of these so-called « colonial » francs was intended to allow these territories to acquire a certain degree of monetary autonomy.

The CFP franc’s peg to the euro ensures its credibility and guarantees economic stability through price stability provided by the European Central Bank and unlimited convertibility guaranteed by the French Treasury.

The unlimited convertibility of the CFP franc is established through an operating account opened in the name of the IEOM in the books of the French Treasury. It frees the territories from the external economic constraint of defending currency parity. Macroeconomic imbalances, such as trade deficits and current account deficits, are financed by the French government through public transfers that balance the balance of payments by rebalancing the supply and demand for CFP francs.

Indeed, the balance of payments (consisting of the current account, the financial account, and errors and omissions) must always be balanced. Taking the case of French Polynesia, we can see that the current account surplus (31.3 billion CFP francs in 2015) masks a high trade deficit (-147.4 billion CFP francs), or 26.7% of Polynesian GDP, which is offset by net transfers from the State equivalent to 24.3% of GDP (134 billion CFP francs in 2015).

The main items in French Polynesia’s balance of payments

While the unlimited convertibility of the CFP franc gives it a certain credibility, its limited use makes it less credible on the international stage. As the CFP franc is not convertible outside its borders, it is not recognized in international trade. The use of this currency therefore hinders the price competitiveness of French Polynesia, New Caledonia, and Wallis and Futuna. Hence the importance of changing the monetary system of these territories.

The consequences of switching to the euro

The possibility of switching to the euro is regularly discussed in French Polynesia, while the issue is still under debate in New Caledonia. Wallis and Futuna will follow the decision taken by New Caledonia.

Initially, the switch to the euro in these three Pacific territories would lead to lower interest rates thanks to the introduction of banking competition at the European level. Subsequently, the fall in interest rates, coupled with the disappearance of the risk premium linked to the risk of devaluation (although this risk is relatively low), would lead to a reduction in the cost of debt. In addition, direct access to international capital markets, i.e., access to diversified financing, as well as the lower cost of credit that a switch to the euro would bring, would facilitate trade and thus increase local investment and foreign capital flows to the Pacific territories. The switch to the euro would also facilitate trade, as the euro is a stable, credible, and convertible currency abroad (unlike the CFP franc). It could therefore boost exports from these territories. However, adopting a strong currency such as the euro could also exacerbate the territory’s difficulties, particularly its lack of export competitiveness.

Furthermore, the change in monetary regime would entail a financial cost linked to the risk of inflationary shock, which would need to be monitored by establishing credible price surveillance in these territories where the cost of living is particularly high (+39% consumer prices compared to mainland France in March 2016). The introduction of the euro would also entail financial costs linked to practical operations such as the modification of company software. Finally, the switch to the euro would put an end to the unlimited convertibility of the CFP franc and thus to the possibility of devaluation (even though this has never occurred) thanks to public transfers balancing the balance of payments. Initially, a switch to the euro would increase the importance of net public payments by the State to avoid a balance of payments crisis. However, this effect could be offset by the increase in trade and the facilitation of trade that the switch to the euro would bring.

Finally, the switch to the euro would lead to the disappearance of the preferential financing procedures granted by the IEOM (rediscount mechanism at preferential rates to help refinance credit institutions, bank loans to SMEs at preferential rates), although these mechanisms only concern a minority of loans (2% of total loans in French Polynesia).

Furthermore, these territories would retain the fiscal neutrality they enjoy in the event of a switch to the euro, as they are not subject to the Maastricht criteria that apply to France (public deficit below 3% of GDP, public debt below 60% of GDP) due to their specific legal status.

Conditions for switching to the euro

French Polynesia and New Caledonia meet most of the criteria for an optimal currency area to join the European Monetary Union, namely economic and financial integration with mainland France through public transfers and trade integration. Endogenous criteria are also met, in particular the credibility of the Central Bank. The criteria lacking in these territories include low price and wage flexibility, low labor mobility, and a lack of diversification in production.

The transition to the euro requires a unilateral agreement by these three French territories in the Pacific. If these three territories agree to adopt the euro, the process of transferring monetary powers from France to the European Union would take at least three years.

Polynesia has expressed its support for the transition to the euro through the adoption of a resolution on January 19, 2006, calling for the introduction of the euro under three conditions:

– Not changing the current CFP franc-euro parity, i.e., ensuring the full convertibility of all assets without any discount when the euro is introduced;

– Ensure the preservation of French Polynesia’s statutory powers under the statutory law of February 27, 2004, which strengthens French Polynesia’s autonomous status by granting it common law jurisdiction. With this status, the State retains jurisdiction over this territory in its sovereign missions, particularly in the areas of defense, justice, foreign policy, security, and support for municipalities;

– Financial assistance from the State to French Polynesia to support the costs associated with the transition to the euro in order to limit inflationary shock. Several studies have shown that the transition to the euro had an inflationary impact in the eurozone countries (0.2% across the eurozone as a whole, according to Eurostat[5]), with a significant gap between perceived inflation and actual inflation. Perceived inflation is higher than actual inflation due to price increases affecting mainly everyday purchases. However, French communities in the Pacific are particularly vulnerable, with a very high cost of living and high levels of inequality. Thus, even a limited price increase would have a particular impact on the poorest populations and would further widen inequalities.

Conclusion

While French Polynesia and Wallis and Futuna seem favorable to a switch to the euro, the issue remains unresolved for New Caledonia, which has been engaged in an institutional process of emancipation from mainland France since the signing of the Nouméa Accords in 1998.

The switch to the euro is unlikely to happen before the outcome of the referendum on full sovereignty scheduled for 2018. If New Caledonia becomes independent, the territory could adopt its own currency, a powerful symbol of national sovereignty.

Other monetary options could then be considered, such as a currency board, which establishes a quasi-fixed parity with an anchor currency/currency basket, or an Austral Monetary Union with Pacific trading partners (Australia, New Zealand).

Bibliography

Dropsy V. (2007), French Polynesia and the Euro

IEOM (2017), New Caledonia’s Balance of Payments, 2015 Annual Report

IEOM (2017), French Polynesia’s Balance of Payments, Annual Report 2015

IEOM (2014), The History of the Pacific Franc

Lagadec G. (2010), New Caledonia: between emancipation, transition to the euro, and the search for new resources, Region and Development No. 31-2010

Markusen B. (2008), What monetary anchor for the Pacific Franc?

La dépêche de Tahiti (2017), Will Fenua ever see the euro in circulation?

La Tribune (2016), Will French Polynesia switch to the euro?