One of the objectives of the ECOWAS monetary co-operation program is the establishment of a single monetary zone. The monetary co-operation program is characterised by either irrevocably fixed exchange rates or a single currency. This unit of currency that will replace all national currencies is known as the ECO.
The case for policy co-ordination and exchange rate management are closely related. Some might even argue that national policies should be co-ordinated and that exchange rates should be stabilised are two of the same ways of saying the same thing. If imbalances in national fiscal and monetary policies cause fluctuations in exchange rates and the private sector confidence is low, then co-coordinating those policies will eliminate the instability.
Since the mid-1970s, countries in the region have altered their exchange rate regimes. They have moved away from pegging to an individual currency like the Pound Sterling, towards adopting a more flexible arrangement under which the domestic currency is frequently adjusted. This is done to minimise the adverse effects on their economies of fluctuations in the exchange rates of major currencies that have taken place since the advent of the generalised floating in 1973.
By contrast, the fixed exchange rate of the Communaute Financiere Africaine (CFA) franc zone countries held its ground as these countries maintained their currency union arrangement with one substantial devaluation of 50 percent in January 1994.
The two big advantages of fixing the exchange rate are (1) reduce exchange rate risk, which encourage trade and investment, and (2) provides credible anchor for monetary policy. Selecting a fixed exchange rate arrangement is equivalent to accepting a constraint on national economic policies. A fixed exchange rate may provide a highly visible commitment and thus raises the political costs of loose monetary and fiscal policies.
The CFA franc zone is the most prominent example in the region of an exchange rate arrangement in which a group of sovereign countries have combined not only to use a single currency, but also to peg the value of that currency firmly to that of another currency.When one country adopts the currency of another, the trade links between them are subsequently strengthened. All the countries in the CFA region have low inflation rates, but the maintenance of uniformly low inflation rates has placed pressure on the financial systems in a few countries.
The CFA countries trade heavily with France and pegging their exchange rate to the French francs initially and then the Euro at a fixed exchange rate, has contributed to overall stability and attractiveness of the currency in the sub-region for private business transactions. The currency is issued by supranational central bank (the Banque Centrale des Etats des Afrique l’Ouest BCEAO). The CFA franc countries have gained both discipline and credibility in the formulation of monetary policies.Fixed exchange rates forces a country to avoid regular depreciation of the domestic currency and high inflation rates. The monetary discipline provided by fixed exchange rates can also lead to fiscal discipline, because deficit financing is limited to a certain percentage of the countries previous years revenue.
In contrast, a flexible exchange rate arrangement, in principle, indicates the desire to accept no constraint on the pursuit of any particular domestic economic policy package. The big advantage of a floating exchange rate is the ability to pursue independent monetary policy. Arguments for flexible exchange rates, emphasise the insulating properties of exchange rate adjustment in the face of external shocks – that is faced with movements in the foreign price level, domestic prices can be stabilised by a suitable adjustment in the exchange rate.
The formal objective of the establishment of an ECOWAS exchange rate mechanism (ERM) is the stabilisation of nominal exchange rates across member countries. However if the ERM is to be a stepping stone to monetary union, it must ensure that the international competitiveness of the various countries is preserved, otherwise the temptation would arise for member countries to respond to idiosyncratic shocks and offset losses in competitiveness by innovations in commercial polices.
The exchange rate regimes in ECOWAS countries clearly demonstrates that countries that adopted a pegged exchange rate regime, (CFA countries) had on average substantially lower rates of inflation because individual countries surrendered the power to alter the exchange rate to a supranational central bank (BCEAO). Many argue that under a fixed exchange rate regime the authorities can gain credibility in macroeconomic policies. A fixed exchange rate regime provides an unambiguous objective “anchor” for economic policy that can help establish the credibility of a program to bring down inflation. The reason for this seems intuitively obvious. In fixed exchange rate regimes, monetary policy must be subordinated to the requirements of maintaining the peg. This in turn means that other key aspects of policy, including fiscal policy, must be kept consistent with the peg, effectively “tying the hands” of the authorities. A country trying to maintain a peg may not for example be able to increase its borrowing through the bond market because this may affect interest rates and hence puts pressure on the exchange rate peg. So long as fixed exchange rate is credible, expectations of inflation will be restrained.
The CFA Zone countries show that there is a strong link between fixed exchange rates and low inflation in the subregion. This results from a discipline effect (the political costs of abandoning the peg induces tighter policies) and a confidence effect (greater confidence leads to a greater willingness to hold domestic currency rather than goods or foreign currencies). In part, low inflation is associated with fixed exchange rate because countries with low inflation are better able to maintain an exchange rate peg. The CFA franc has been extensively used by the private sector in ECOWAS countries to finance international transactions due to its convertibility and credibility factor.
In 2000, The Heads of State of The Gambia, Ghana, Nigeria, Sierra Leone and Guinea (later Liberia) as part of the fast track approach to economic integration established the second monetary zone, which is known as the West African Monetary Zone (WAMZ). At that time, it was envisaged that this Zone would merge with the UMEAO (the CFA Zone) to form a single monetary zone in West Africa for the 15 ECOWAS countries.
For this to happen, the West African Monetary Institute (WAMI) was set up in Accra, Ghana and began operations in 2001. The Institute is to undertake technical preparations for the establishment of a common West African Central Bank and the launching of a single currency for the West African Monetary Zone (WAMZ).
The initial date for the launch of the single currency was set for 2003, with further postponements to 2005, then 2009 and 2015. After all these postponements since 2003, the ECOWAS Heads of State at their meeting in Abuja in June 2019 unanimously agreed that the ECO will be launched in 2020. Is this feasible given the history of the WAMZ since 2000? The reason for these series of postponements was due to WAMI Member States’ lack of compliance with meeting the convergence criteria both primary and secondary convergence criteria.It would appear that political expediency took precedence over achieving macroeconomic fundamentals when this announcement was made by Heads of State.
For the ECO to be operations in the West African Monetary Zone (WAMZ), key institutions need to be in place such as
- The Authority of Heads of State and Government
- The Convergence Council
- The Technical Committee
- The West African Monetary Institute
- The West African Central Bank
- The WAMZ Secretariat
- The Stabilization and Cooperation Fund
- The West African Financial and Supervisory Authority.
Some of these institutions exist but it is very clear that not all of these institutions are in place. The most important of these, the West African Central Bank have not been created. In addition, important organs such as the stabilisation fund as well as the financial and supervisory authority have not been set up. On the balance of probability is it highly unlikely and it is not feasible that in the next six months or even one year all of these institutions will be fully operational.
Macroeconomic Convergence and Stability Pact between ECOWAS Member States list the following as the convergence criteria:-
Primary convergence criteria
- Ratio of budget deficit (including grants) to GDP (less than or equal to 3%)
- Annual average inflation rate (less than or equal to 5% in 2019)
- Central Bank financing of the budget deficit – a maximum of 10 % of the previous year’s tax revenue
- Gross external reserves (more than or equal to 3 months of imports)
- Debt-to-GDP ratio (less than or equal to 70%)
- Nominal exchange rate variation (±10%)
Let us look at The Gambia’s readiness in meeting the ECOWAS convergence criteria using data for 2018, although ideally the country needs to register a record of accomplishment of consistently meeting the criteria over a long period of time.
|Convergence Criteria for The Gambia||2018||Remarks|
|Ratio of Budget deficit (including grants) to GDP (less than or equal to 3%)||-6.6||Not achieved|
|Annual average inflation rate (less than or equal to 5% in 2019)||6.5||Not achieved|
|Central Bank financing of the budget deficit – a maximum of 10 % of the previous year’s tax revenue||Not achieved|
|Gross external reserves (more than or equal to 3 months of imports)||2.4||Not achieved|
|Debt-to-GDP ratio (less than or equal to 70%)||83.2||Not achieved|
|Nominal exchange rate variation (±10%)||Less than 10%||Achieved|
Data from IMF Regional Economic Outlook: Sub Saharan Africa
The table above shows that using 2018 data for The Gambia from the IMF Regional Economic Outlook for Sub Saharan Africa, the country met only one out of the six convergence criteria and the country did not meet any of the primary convergence criteria.
The 2016 ECOWAS convergence report, gives convergence results for The Gambia from 2012 to 2016. One can see from the table below that with the exception of nominal exchange rate variation, none of the convergence criteria was met in 2016.
|Ratio of budget deficit to nominal GDP||≤ 3%||-4.6||– 8.7||– 9.7||– 6.3||– 9.5||Not achieved|
|Annual average inflation rate||≤ 10% with objective of ≤ 5% in 2019||4.3||5.7||6.9||6.8||7.9||Achieved|
|Central Bank financing of the budget deficit||≤ 10% of previous year’s tax revenue||0.4||0.0||40.8||41.5||33.1||Not achieved|
|Gross external reserves||≥ 3 months||4.8||4.6||3.7||2.5||2.4||Not achieved|
|Ratio of total public debt to GDP||≤ 70%||78.0||88.1||104.1||101.1||117.3||Not achieved|
|Nominal exchange rate variation||± 10%||-4.5||-10,3||-16.5||-4.9||-3.3||Achieved|
Source: ECOWAS Commission – 2016 Convergence Report.
This simple analysis for The Gambia shows that the country have a long way to go to achieve any meaningful degree of monetary policy convergence. Given the small size of the economy, the Gambia stands to gain from its integration into the ECOWAS regional market. It is in the country’s best interest to ensure that the macro fiscal policies comply with the ECOWAS convergence criteria.
It would have been useful for policy makers in the Gambia to adequately brief the President before attending the ECOWAS Heads of State meeting so that he can be better informed and to explain to his peers that the timetable given for adopting the ECO is not realistic for the Gambia because the country is facing macro-economic challenges. Doing such analysis is relatively straightforward and useful for policy dialogue.
Ps: this article is based on a chapter in my PhD thesis on “Growth, Convergence and Economic Integration in ECOWAS”, supplemented with information from ECOWAS and WAMI.
CFA countries – Benin, Burkina Faso, Cote d’Ivoire, Guinea Bissau, Senegal, Mali, Niger, Senegal, Togo
WAMZ countries – Gambia, Ghana, Guinea, Liberia, Nigeria, Sierra Leone.
Basil Jones is the Gender and CSO Program and Policy Coordinator in the African Development Bank’s Gender, Women and Civil Society Department. Prior this he was the Advisor to the Special Envoy on Gender and Vice President of the African Development Bank in November 2015 to December 2016. Other positions he has occupied in the Bank are Assistant to the Chief Economist and Vice President, of the Economics Complex from June 2012 to September 2015 and Principal Capacity Development Specialist in the Bank’s Fragile States Unit from June 2009 to May 2012. Before joining the Bank, he worked for 8 years as a Senior Program Specialist with the International Development Research Centre (IDRC) in Senegal and Kenya. He worked at the Central Bank of the Gambia Economic Research Department from 1988 to 1997. He holds a PhD in economics from the University of Hull in UK.