CFA franc members need improved governance, flexible inflation targets

Stronger institutions and inflation targets that are designed for developing countries are more likely to attract and retain foreign investment.

Members of the two CFA franc monetary unions, the Western Africa Economic and Monetary Union (WAEMU) and the Economic and Monetary Community of Central Africa (CEMAC), have lower external vulnerabilities, Moody’s finds in a report on December 12.

• Currency unions “can reduce investor concerns and capital flight risk”, and members have “significantly benefited” from a credible exchange rate peg to the French franc and then the euro, the report says.

Yet Moody’s finds no evidence that WAEMU and CEMAC countries have achieved higher economic growth than non-CFA franc African countries since 1994, when WAEMU and CEMAC were formally established.

• Despite trade agreements covering the WAEMU and CEMAC countries, low economic diversification has stunted the development of intra-regional trade, it says.
• The unions cover 14% of Africa’s population and 12% of the continent’s GDP.

There is a “mismatch” between CFA monetary policy and the needs of its countries, argues Paris-based OECD economist Koffi Zougbédé. The priority objective of the monetary policy in these regions is to ensure price stability with an inflation target between 1% and 3%.

Targeting this level of inflation can be costly, Zougbédé says. The target is similar to the European Central Bank (ECB) goal of 2%, which he sees as “inadequate” in the CFA zone.

• Zougbédé points to studies such as Politique monétaire et servitude volontaire by Kako Nubukpo in 2007, which show that in developing countries, inflation levels between 7% and 11% stimulate production, versus 2% to 3% in developed economies.
• “Being in the CFA zone does not appear to generate any benefits in terms of growth,” Zougbédé says. The low inflation target, he says, “could be costly . . .  A change in the conduct of the monetary policy in the zone might be worth it.”
• The case is not clear-cut: Zougbédé notes that other sub-Saharan countries with higher inflation are not doing any better, or even worse.

Weak Institutions

Currency zones are designed firstly to limit volatility. They are not a panacea for governance issues. All countries in WAEMU and CEMAC have performed “relatively weakly” in terms of government effectiveness, rule of law and control of corruption, Moody’s finds.

• Since 1996, institutional quality has worsened in economies such as Equatorial Guinea, Gabon and Côte d’Ivoire.

According to Moody’s, the CFA franc from 1995 to 2019 was less volatile than the South African rand against the US dollar. In 2020, the risk of South Africa losing its last remaining investment-grade rating could trigger capital flight from the whole continent.

Zougbédé is sceptical that CFA membership will offer much protection in that worse-case scenario.

• CFA countries must “improve their governance and create strong institutions to manage capital flows,” he says.
• “Stability and low inflation will not be enough to attract investors. Business environment matters as well as political stability and security.”
• Regional policies and strategies, Zougbédé argues, are needed to attract investment.

Bottom Line: If capital flight becomes a reality, stronger institutions will offer better protection for CFA countries than a one-European-size-fits-all monetary policy.