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Authors: Hu Si Ying and Jasmine Chin Region Head: Hu Si Ying
Editor: Praharsh Mehrotra
Illustration by Chen Hsuan Ju
Abstract
Eco - the common currency for West Africa was aimed to be implemented in 2020, however this was announced to be stalled for another 3 years ahead at least. In this article, we discuss the benefits and challenges to implementing a monetary union in detail and what member countries should do to work towards a smooth implementation of the common currency.
Introduction
The Economic Community of West African States (ECOWAS) has planned to adopt the Eco, a common currency for the region, since 2003. Yet, implementation has continuously been delayed with the latest update suggesting that the 2020 deadline will not be met.
The ECOWAS is a regional trading union with an aim to promote economic integration and collective self-sufficiency for member states (ECOWAS, n.d.). It comprises 15 member countries from 2 sub-regional blocs - the West African Economic and Monetary Union (WAEMU) and the West African Monetary Zone (WAMZ). WAEMU consists of mainly French-speaking countries who use the West African CFA Franc (WAEMU, n.d.) while the WAMZ consists of mainly English-speaking countries (WAMZ, n.d.). Unlike WAEMU, the WAMZ countries each have their own currencies. For example, Nigeria uses the Naira while Ghana uses the Cedi.
Last December, WAEMU announced its decision to retire the CFA Franc and to rename their new single currency ‘Eco’. With this new arrangement, countries who use the Eco will no longer be required to store half of their reserves in the French treasury, and the French will withdraw their influence from the workings of this currency (Hairsine, 2020).
This move angered the WAMZ members who wanted a single currency to be implemented across the whole ECOWAS region and not just for the Francophone countries (Brookings, n.d.). Due to the hard-hitting economic impacts of the COVID-19 pandemic, it is not optimistic that the Eco will be put into action for another 3 to 5 years (Smith, 2020).
Benefits of implementation
Having an Africa-based common currency like the Eco (pegged to Euro) can help to boost the level of trade for many trade-starved countries of West Africa, leading to greater economic growth and prosperity that impacts the region’s 385 million people (Marchand, 2020). This is because a common currency that is accepted throughout the region can make for easier payments and reduce the cost of doing business for big and small businesses alike (Marchand, 2020). Drawing from the experience of the Eurozone, the only other regional common currency in the world today, studies have shown that the Euro increased trade within the Eurozone, due to the fact that the Euro has lowered fixed and/or variable costs of exports, thus making it more profitable for smaller firms to export (Nitsch & Pisu, 2008). Thus, a common currency can potentially help boost West Africa’s regional trade. This would be a timely and positive development that moderates the brunt of COVID-19 economic devastation on export-driven countries such as Cote d’Ivoire and Burkina Faso (OECD, 2020).
In addition, a fixed currency eliminates exchange rate risks. This would improve business and investors’ confidence, and hence see more foreign investments flowing into the West African region.
With higher capital inflow, liquidity will be boosted in the regional equity and debt markets. Regional firms can also gain greater access to capital as local and foreign brokers and investors can now get a single membership to access the various ECOWAS stock exchanges as part of the monetary union (Marchand, 2020).
Therefore, adopting Eco will potentially allow ECOWAS to see a common inflation rate and interest rate, growth in trade, productivity and financial integration, and hence an overall increase in economic growth and well-being. These are potential benefits of monetary unions, as propelled by Robert Mundell (1961) in ‘A Theory of Optimum Currency Areas’ (Mutungi, 2020).
Challenges of implementation
Although West Africa stands to gain much from implementing the Eco, there are structural challenges hindering this process. In order to implement a common currency while maintaining free capital flow, ECOWAS nations would have to give up autonomous monetary policy due to the constraints presented by the Mundell-Fleming trilemma. This also means that a supranational central bank has to be set up to coordinate the interest rate across ECOWAS. As such, two structural problems - the stringent criteria for fiscal convergence and the lack of institutional structure to synchronize banking legislation are hindering the process to set up Eco.
First, there is a rigid criteria that needs to be met by member countries prior to full implementation. Member states of ECOWAS are required to keep their budget deficits lower than 3% of their respective GDPs, ensure that the public debt ratio is no more than 70% of their GDP, push the inflation rate below 10% per annum, as well as maintain at least 3 months of import cover (Smith, 2020). With these regulations, only two small countries, Togo and Conakry Guinea, qualify. Meanwhile, some countries are battling high debt or inflation. For example, Ghana has seen increasing public debt over the past few years, which means that it will be hard for them to contain their budget deficits. (Hairsine, 2020). With the Covid-19 pandemic taking a toll on the African countries, more countries are most likely unable to meet the criteria.
A rigid criteria is needed because fiscal discipline is key for the success of a monetary union. Economies that are more convergent will be able to reap higher benefits from being in a monetary union as argued in Mundell (1961). Moreover, an IMF study has shown that the lack of fiscal convergence and not asymmetric shocks or low level of regional trade is the main difficulty in the establishment of a smooth functioning monetary union in West Africa (IMF, 2002). To illustrate the problems of large fiscal distortions when entering a monetary union, consider the Guinean economy with an estimated GDP of USD 10.9 billion versus the Nigerian economy with an estimate of USD 397.3 billion. Such disparities are reminiscent of the different situations strong economies like Germany and weak economies like Greece faced during the 2008 crisis. Strong economies are more well positioned to weather shocks than weak economies. A common currency strips individual countries’ ability to adjust interest rates for different purposes and in the case of Greece, the inability to lower interest rates to suit their expansionary needs meant they had to resort to austerity measures which worsened their fiscal position (Johnston, 2020). Thus, emphasizing the importance of fiscal convergence to benefit from a similar monetary policy.
Second, there is a lack of institutional structure in the West African region to help facilitate this move to implement Eco. For the Eco to hold any weight in the international arena, there is a need for a treaty governed by international law among all the member states, setting out regulations and authorising a central bank to hold the reserves of member states (Fröhlich, 2019). There is currently such a central bank, the Central Bank of West African States (BCEAO), which is the central bank for WAEMU, which supervises the workings of the CFA Franc (Smith, 2020). However, the BCEAO is slow to report financial data and lacks transparency in many aspects of financial reporting (Smith, 2020). Moreover, a supranational central bank will be needed to coordinate between WAEMU and WAMZ, there is currently no statute for a new central bank, thereby highlighting the lack of political agreements (Fröhlich, 2020).
Recommendations
ECOWAS nations have to work towards fiscal convergence if they want a common currency to be implemented smoothly. This remains a challenging and the most critical issue for all members to meet the criteria. Other than the fiscal position, there are huge infrastructural problems, such as the lack of proper roads, railways and air connection to facilitate the free movement of goods. Unnecessary road blocks by bureaucratic officers also hinder the free movement of goods and services (Ekpo, 2020). Of course, investing in infrastructure will incur higher debt if governments need to borrow to fund these projects, making it harder to achieve the criteria aim.
Nevertheless, there are some arguments that might support monetary unions with loose convergence. For one, once a monetary union is created, many common institutions and practices may be introduced which can then build towards convergence. New union institutions may be seen as an important cooperative step that can create impetus for overall development in line with a common vision. Another would be that economies that lack resources to maintain economic and financial conditions themselves can rely on larger or stronger members to provide help or guidance (Enoch & Krueger, n.d.).
Therefore, we would recommend that members work towards fiscal convergence to the best of the ability and while not all can be fully met at the end of the day, larger members can demonstrate political commitment and willingness to assist the weaker economies when the union is formed. Nigeria, the region’s biggest economy has been known for its refusal to engage in intra-African co-operation in the past few years (Smith, 2020). Better political cooperation would be needed. We also recommend higher surveillance on more divergent economies so as to assist them as much as possible before a problem arises.
Conclusion
The road towards implementing Eco will be a bumpy one, however, potential benefits are attainable if countries work towards some trend of convergence at least, and if the central banks take initiative to implement policy coordination and surveillance framework to monitor the performances of member countries regularly.
References
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