Is It Desirable and How Could It Be Achieved?
Paul Masson and Catherine Pattillo
On April 20, 2000, in Accra, Ghana, the leaders of six West African countries1 declared their intention to proceed to monetary union among the non-CFA2 franc countries of the region by January 2003, as a first step toward a wider monetary union including all the ECOWAS3 countries in 2004. The six countries committed themselves to reducing central bank financing of budget deficits to 10 percent of the previous year's government revenue; reducing budget deficits to 4 percent of GDP by 2003; creating a Convergence Council to help coordinate macroeconomic policies; and setting up a common central bank. Their declaration states that, "Member States recognize the need for strong political commitment and undertake to pursue all such national policies as would facilitate the regional monetary integration process."
The goal of a monetary union in ECOWAS has long been an objective of the organization, going back to its formation in 1975, and is intended to accompany a broader integration process that would include enhanced regional trade and common institutions. In the colonial period, currency boards linked sets of countries in the region. On independence, however, these currency boards were dissolved, with the exception of the CFA franc zone, which included the francophone countries of the region.4 Although there have been attempts to advance the agenda of ECOWAS monetary cooperation, political problems and other economic priorities in several of the region's countries have to date inhibited progress. Although some problems remain, the recent initiative has been bolstered by the election in 1999 of a democratic government and a leader who is committed to regional integration in Nigeria, the largest economy of the region, raising hopes that the long-delayed project can be revived.
The plan to create a second monetary union (in addition to that constituted by the West African Economic and Monetary Union, or WAEMU),5 as well as a full ECOWAS monetary union, raises a number of questions about the advantages and disadvantages of various alternative arrangements and strategies. There is clearly an important political dimension behind the recent initiative, but it is nevertheless important to carefully examine the economic benefits and costs. The institutional design of the non-WAEMU monetary union could take a number of different forms, including the creation of a new currency or the adoption of an existing one, the formation of a single central bank or its coexistence with national central banks, and a peg (e.g., to the euro or a currency basket) or a flexible exchange rate for the external exchange rate policy of the common currency. The second stage, involving the merger of the two currency unions, raises some of the same issues. The second stage also raises additional issues, such as whether the French Treasury's guarantee of convertibility of the CFA franc to the euro, at a fixed parity, would continue.
The purpose of this paper is to evaluate whether a monetary union makes economic sense, to discuss the institutional requirements for a successful monetary union, and to consider how best the political momentum for a union can be channeled toward a fundamental improvement in underlying policies. After giving details of the ECOWAS monetary union project, the paper reviews the economic situation of the ECOWAS members, with the objective of evaluating the ease with which they can proceed to a common currency. Next, the paper considers the requirements for creating a successful monetary union, drawing lessons from existing monetary unions. Naturally enough, the performance of the CFA franc zones--one of which, WAEMU, is comprised of eight countries in West Africa--provides some of the most relevant lessons. Although the CFA franc has delivered low inflation, growth performance in WAEMU has not been consistently better than in other sub-Saharan African countries, and trade among member countries remains relatively low. The exchange rate and banking crisis in the second half of the 1980s and early 1990s showed that fiscal policy must be disciplined and central banks must be insulated from indirect financing of budget deficits through the banking system. Other currency unions, in particular the European Union's 12-member Economic and Monetary Union, illustrate the need for extensive institutional preparation and the need for participants first to achieve economic convergence.
In considering the possible net economic benefits of monetary union, similarity of production structures, factor mobility, flexibility of wages and prices, and symmetry of shocks hitting the economies all enhance the attractiveness of such a union. In fact, there are major differences among the West African economies. In particular, Nigeria, a major oil exporter, faces a very different pattern of terms of trade shocks than the other economies of the region. Moreover, existing internal trade among the region's countries is quite low, although there is undoubtedly considerable informal trade that is not recorded. Of course, one of the reasons for proceeding to monetary union quickly is to promote improvement in macroeconomic policies and to enhance prospects for other aspects of regional integration, including regional trade. The empirical literature is not definitive, but it does suggest some boost to the trade among members of a monetary union.
Next, the paper discusses various institutional options for implementing monetary cooperation within ECOWAS. A distinction is made between full monetary union and looser forms of monetary cooperation, such as an informal monetary union. The attractiveness of the two options depends in part on the purposes of monetary union. On the one hand, if the union's main purpose is to bring about exchange rate and macroeconomic stability, it may be preferable for the participants to institute mutual surveillance and keep exchange rates within (perhaps very narrow) fluctuation bands or opt for a common external peg. These looser forms of monetary cooperation could achieve this goal at a lower cost than would a full monetary union and its institutional requirements. On the other hand, a full monetary union may have advantages over looser forms of cooperation, such as providing a more effective "agency of restraint" (Collier, 1991) for domestic policies. In this context, national central banks acting alone may not be able to achieve the necessary discipline, but a supranational institution might be able to do so, through peer pressure and externally imposed sanctions. Setting up a central bank and eliminating national currencies will take longer than the planned timetable, however, and it would be wasteful of resources to create new institutions if they disappear shortly thereafter, when the second monetary union merges with WAEMU.
Several strategic decisions must be made if the full monetary union option is selected initially or, in any case, at the time of the creation of a full ECOWAS monetary union. The first choice is that of a central bank for the monetary union. Unfortunately, none of the non-WAEMU countries has a central bank with a track record of currency stability and low inflation. Nigeria, which accounts for more than half the population of ECOWAS and 75 percent of the GDP of the six countries proposing an initial monetary union, would be a natural candidate to form the nucleus of monetary union, but Nigeria has a history of high inflation and the Nigerian currency is inconvertible. A second choice associated with a full monetary union is whether the region's common currency(ies) should have an external exchange rate anchor, such as a peg to the euro. An independent peg of each of the currencies to the euro would provide exchange rate stability within the region (as well as with the 12-member euro area and with the neighboring six-member Central African CFA zone). A euro peg thus could deliver some of the advantages of a common currency without extensive institutional preparation. Choosing to peg to a basket rather than to a single currency, however, would permit some insulation from the fluctuations among major currencies. Finally, the issue of whether the French Treasury's guarantee of convertibility6 will continue would arise if and when a merger of the second monetary zone and WAEMU is contemplated.
This paper discusses these issues and considers the proposal for a monetary union from a wider perspective of the prospects for regional integration. The paper concludes that it is important to recognize that monetary union is neither necessary nor sufficient to achieve other aspects of regional integration, in particular intraregional trade, as the contrasting examples of the North American Free Trade Agreement (NAFTA) and the CFA zone illustrate. Moreover, the objective of monetary union should not be allowed to distract attention from addressing the serious domestic problems faced by countries in the region, which will mainly be resolved by "putting one's house in order" and opening up the economies externally by removing the obstacles to trade posed by tariffs, other forms of protection, poor transportation infrastructure, and divergent regulations and codes. Instead, the process of strengthening mutual surveillance should be used to provide a powerful channel for each country to converge on good policies, and this could be the most important major benefit from regional integration. Thus, instead of trying to meet a very short deadline for monetary union, the countries of the region should invest their energies in reinforcing convergence on low inflation, sustainable fiscal policies, and structural policies necessary for strong growth. A degree of exchange rate stability as well as the benefits of mutual surveillance over macroeconomic policies could be achieved through a looser form of regional monetary cooperation.
1The meeting was attended by three heads of state, Presidents Olusegun Obasanjo of Nigeria, Jerry Rawlings of Ghana, and Lansana Conté of Guinea, as well as representatives from Liberia, Sierra Leone, and The Gambia. Cape Verde, the remaining non-CFA ECOWAS member, has a currency peg to the euro with the support of Portugal, and was not a signatory of the "Accra Declaration on a Second Monetary Zone." Mauritania, a founding ECOWAS member, recently withdrew from the regional organization.
2CFA stands for "Communauté financière africaine" when it refers to the West African franc zone.
3ECOWAS, or Economic Community of West African States, is composed of the seven countries mentioned in the first footnote, plus the eight countries that are members of the West African Economic and Monetary Union--namely, Benin, Burkina Faso, Côte d'Ivoire, Guinea-Bissau, Mali, Niger, Senegal, and Togo.
4Guinea and Mali left the CFA zone upon independence, but Mali later rejoined.
5WAEMU is an eight-member economic and monetary union. The French acronym for WAEMU is UEMOA (l'Union Economique et Monétaire Ouest Africaine). The common currency of the WAEMU countries, the franc de la Communauté financière de l'Afrique (CFA franc), is issued by a single central bank, the Banque Centrale des Etats de l'Afrique de l'Ouest (BCEAO). WAEMU's CFA franc is pegged to the French franc, which since 1999 has been a subunit of the common European currency (euro).
6The French Treasury currently has sole responsibility for guaranteeing convertibility of CFA francs into euros, without any monetary policy implication for the Bank of France (French central bank) or the European Central Bank. The two CFA central banks maintain an overdraft facility with the French Treasury, subject to operating rules that have applied since 1973. Each CFA central bank must keep at least 65 percent of its foreign assets in its operations account with the French Treasury; provide for foreign exchange cover of at least 20 percent for its sight liabilities; and impose a cap on credit extended to each member country equivalent to 20 percent of that country's public revenue in the preceding year.