Abstract :
• The CFA franc is the currency of two separate monetary unions, and its free convertibility into euros is guaranteed by the Bank of France at a fixed rate with the euro.
• It is a source of stability in terms of growth and inflation, particularly compared to African countries that do not use it;
• However, its current functioning is contested, notably because it deprives member countries of any monetary sovereignty and its microeconomic gains are mixed.
The CFA franc is used by around 150 million people. Created in the aftermath of World War II, it withstood the decolonization movements in Africa and is now one of the last institutional traces of the French colonial empire. Theoretically justified by its gains in terms of stability and exchange rate credibility, it is now the subject of much criticism.
Indeed, its free convertibility into euros and fixed parity, which limit exchange rate uncertainties, come at the cost of monetary sovereignty, and its microeconomic benefits are disputed.
Functioning and history of the CFA franc
The CFA franc is the currency of two monetary zones in Africa, comprising a total of 14 countries. On the one hand, there is the West African Economic and Monetary Union (UEMOA), where the CFA franc stands for the franc of the African Financial Community, which includes Benin, Burkina Faso, Côte d’Ivoire, Guinea-Bissau, Mali, Niger, Senegal, and Togo. On the other hand, there is the Central African Economic and Monetary Community (CEMAC), whose currency is the franc of the African Financial Cooperation, comprising Cameroon, the Republic of Congo, Gabon, Equatorial Guinea, the Central African Republic, and Chad. If we add the Comoros and three Pacific territories (French Polynesia, Wallis and Futuna, and New Caledonia), we obtain the entire franc zone.
Diagram. CFA franc countries
Source: BSI Economics
Today, €1 is worth 655.957 CFA francs from the WAEMU or CEMAC. This fixed parity is guaranteed by the French Treasury: CFA francs can be freely converted into euros at this rate. However, the two zones do not constitute a monetary union between them: since 1993, a UEMOA CFA franc cannot be used for payments in the CEMAC zone and vice versa; conversion is required, which incurs exchange fees.
Free convertibility is ensured by a drawing right on an operating account with the French Treasury, which the central banks of both zones can use in the event of a liquidity shortage. In return for this guarantee of convertibility into euros, they must deposit 50% of their official reserves in this account, which functions as a demand deposit account and therefore earns interest. The guarantee also comes with a number of controls on the fiscal, monetary, and exchange rate policies of member countries.
These two zones were transformed during the independence and decolonization movements. Initially known as the franc of the French colonies, the CFA franc was created in 1945 when France ratified the Bretton Woods agreements. Member countries then had a common currency in their respective zones at a fixed exchange rate with the franc: one CFA franc at the time was worth 2 centimes of the French franc. Free convertibility into francs was accompanied by the operating account mentioned above and strict control of monetary policies.
When the CFA franc became the franc of the French Community of Africa in 1958, it was increasingly accused of maintaining dependence on the former colonizer. Several countries abandoned the CFA franc (Guinea in 1960, Mali in 1962, Madagascar in 1973), which partly highlighted its stabilizing virtues (Mali re-adopted the common currency in 1984). It was devalued by half in 1994, then pegged to the euro in 1999 without any change in its institutional functioning. Today, the crisis in the euro zone has reignited criticism of the CFA franc.[ii]
The supposed advantages of the CFA franc
The argument most often put forward in favor of the CFA franc is that it guarantees economic stability for its member countries, particularly in terms of inflation.
Pegging to a stable currency, the euro, and free convertibility are advantages in themselves. This allows for microeconomic gains by limiting the uncertainty associated with exchange rate fluctuations, strengthening the credibility of the CFA franc and, in theory, encouraging the inflow of foreign capital. In addition, it protects member countries from violent exchange rate movements, which can increase the value of debts and imports denominated in foreign currencies.
The fixed parity is accompanied by the statutes of the Banque de France, which closely monitor the monetary policy of the CFA franc central banks, ruling out any expansionary monetary policy. This effectively curbs inflation in member countries. This is particularly true when comparing the situation of countries using the CFA franc with that of other African countries. Indeed, the standard deviation of inflation in most WAEMU and CEMAC countries is less than 5%. As the standard deviation is a measure of the dispersion of an economic variable, we can see that the member countries enjoying greater price stability than other African countries are those higher up on the y-axis. This relatively low volatility is also reflected in growth, which is relatively stable. By preventing any « money printing » policies, the CFA franc limits periods of sharp price increases or even hyperinflation, which destroy the value of the currency.
Figure 1. Standard deviations of growth and inflation in Africa
Sources: World Bank, BSI Economics
Furthermore, as they cannot resort to debt monetization, these countries must exercise fiscal discipline or face cash flow problems (they are also subject to a fiscal rule limiting the public deficit to 3% of GDP, similar to that of European countries). This oversight helps to avoid potentially destabilizing fiscal policies.
However, the public deficit can be financed on the markets through the issuance of Eurobonds, for example. African countries are also experiencing growing enthusiasm for their sovereign bonds.[iv] This monetary and fiscal stability allows governments to benefit from lower rates, as in the case of Côte d’Ivoire and Senegal, through reduced risk premiums. This encourages external public debt, but fiscal discipline and monetary stability make it easier and less costly. There is also the benefit of diversification in the type of creditors (in particular, less dependence on international aid and concessional loans) and longer debt maturities, limiting exposure to short-term refinancing risk.
Monetary union between member countries also eliminates transaction costs and exchange rate risk in intra-zone trade. This is another microeconomic gain: in theory, it stimulates growth through trade integration.
Finally, adopting the same currency is an important step in the integration process and, in principle, calls for cooperation and/or coordination of a broader set of economic policies. This paves the way for the convergence of national policies designed to generate economies of scale and positive spillover effects, such as the creation of a common market, the launch of investment projects, or improved multilateral surveillance. For example, a project to allow the free movement of people by eliminating visas for crossing borders is currently underway for CEMAC countries.
A criticized institution
The main criticism of the current functioning of the CFA franc is that it deprives its member countries of any monetary independence. Monetary policy decisions must be approved by the Banque de France. Fiscal sovereignty is also heavily regulated by a set of surveillance mechanisms. It stands to reason that some countries would benefit from pursuing, or being able to decide to pursue, expansionary policies depending on the economic situation. For example, this oversight could prevent a government from pursuing a Keynesian-style stimulus policy through public spending to finance investment projects. For these reasons, the institutional arrangement linking the CFA franc countries (and more generally the franc zone) to France and the euro is considered a form of monetary tutelage.
In this case, this lack of independence is all the more damaging as the monetary policy decided at the European level is not adapted to the needs of the countries. The euro, which is overvalued in relation to fundamentals, penalizes their exports in particular. Member countries are therefore forced to accept economic policy decisions that run counter to their interests.
Furthermore, according to the theory of optimal currency areas, the loss of control over exchange rates and monetary policy to deal with asymmetric shocks must be offset by alternative adjustment mechanisms in order to justify the common currency. In particular, the mobility of production factors (labor, capital) and/or community budget-type transfer mechanisms should facilitate the reallocation of resources from affected regions to regions in better condition. For CFA franc countries, worker mobility is far from a reality, as the free movement of workers is hampered by the requirement for nationals to present a visa to cross borders (with the exception of Cameroon and Chad). In addition, financial markets are insufficiently developed to allow the movement of capital. Finally, for both zones, there is no transfer mechanism.
As for the supposed advantages of monetary integration mentioned above, the CFA franc has not enabled member countries to become privileged trading partners (Figure 2). For example, for the CEMAC zone countries, the share of trade with other member states is low in relation to the overall trade openness ratio. Trade integration therefore appears to be incomplete, and countries do not seem to be really benefiting from reduced transaction costs.
Figure 2. Intra-zone and overall trade openness of the CEMAC
Sources: BEAC, BSI Economics
Furthermore, exchange rate stability is no guarantee of foreign capital inflows. In particular, if the institutional environment (business climate, administrative barriers, corruption) reduces the profitability of capital or generates uncertainty, countries may find it difficult to attract external financing. For CFA franc countries, the amount of foreign direct investment inflows remains low (Figure 3), and in any case generally below the average for African countries. The credibility of the exchange rate must therefore be accompanied by structural reforms that make the territories attractive in terms of FDI.
Figure 3. Foreign financing flows
Source: World Bank, BSI Economics
Finally, the functioning of the operating account is also subject to criticism. The guarantee of the free convertibility of the CFA franc into euros is offset by the deposit of at least 50% of the central banks’ official reserves in an account with the French Treasury. This condition, which is necessary for the functioning of the CFA franc, deprives countries of liquidity that could be used to meet other needs.
Conclusion
During its 70 years of existence, the CFA franc has remained stable despite the independence of the French colonies, and has enabled a high degree of stability, particularly in terms of prices. However, the functioning of the operating account, which rationed liquidity, the pegging effects that imposed European monetary policy decisions on member countries, and mixed microeconomic gains cast doubt on its positive effects. The future of the CFA franc could be that of a common currency that is no longer pegged to the euro, restoring monetary sovereignty, or pegged to a basket of currencies made up of euros, dollars, or even yuan and other currencies.
[i]Deposits in the official reserves of the two African central banks are remunerated by the Treasury at the ECB’s marginal lending rate up to the required amount of 50%, and at the main refinancing rate above that amount.
[ii]See, for example, Sortir l’Afrique de la servitude monétaire : A qui profite le franc CFA ? (2016), published by La Dispute.
[iii]The policy known as « money printing » consists of resorting to money creation that can be used to finance the government deficit.
[v]See Mundell, R. A. (1961). A theory of optimum currency areas. The American Economic Review, 51(4), 657-665., McKinnon, R. I. (1963). Optimum currency areas. The American Economic Review, 53(4), 717-725., Kenen, P. (1969). The theory of optimum currency areas.
