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Is the writing on the wall for the CFA Franc?

The CFA franc, the instrument of Africa’s largest currency union utilized by 14 countries in its sub-Saharan region, has been sentenced to the hot spot in recent months as accusations of “monetary servitude” and “colonial currency” are thrown at the medium of exchange. As discussed in a previous article, the CFA franc’s fixed exchange rate with the euro outsources the currency union’s monetary policy to the hawkish European Central Bank, which although leading to lower inflation in the “Franc Zone” relative to other sub-Saharan economies, has come with a high opportunity cost. Deflationary threats and a looming regional debt crisis may partially be casualties of the tight monetary policy, while both West African and Central African have largely failed to outpace average economic growth in sub-Saharan Africa, falling far short in the former.

This macroeconomic view of the longstanding institution, however, may fail to do justice to other problematic trends that naturally follows from fixing exchange rates between two currency unions on relatively opposite ends of the income scale. Firstly, through the use of a CGE model Brookings found that the fixed euro exchange rate overvalued the CFA franc by 20% in West Africa and by 30% in Central Africa, artificially propping up a larger-than-otherwise trade deficit in the Franc Zone.

Because sub-Saharan countries, including those in the Franc Zone, are much more reliant on exports such as oil, gold, and diamonds for their revenues, an artificial trade deficit greatly hurts these developing economies by discouraging foreign demand for them. Remaining foreign demand, in turn, would likely be concentrated on these lucrative commodity prices, even though sub-Saharan commodity values have been incredibly volatile and generally downward over the last decade. Whereas greater foreign demand for African exports could see diversification within the crucial sub-Saharan exports sector, the lower foreign demand characteristic of a large trade deficit would not only shrink such an important sector, but leave it in a fragile state of specializing in one to a few volatile commodities.

Trade balances, meanwhile, are largely symptoms of capital flows. An excessively stronger CFA franc corresponds with a greater share of foreign direct investment (FDI), with Franc Zone countries showing almost a 5% level of FDI as a share of GDP, compared to the sub-Saharan African average of 3.9%. A greater share of foreign investment implies a greater reliance on foreign countries to maintain a country’s government spending and financial health.

Given that sub-Saharan economic growth tends to be incredibly volatile alongside swings in the prices of commodities that it relies upon for revenue, an increased share of foreign investment leaves the developing region on a shaky foundation as an inability to repay assets such as government debt may quickly turn into a frenzy of outflowing capital, as what happened during the 1997 Asian Financial Crisis. Already, the consequences of greater foreign reliance on the Franc Zone may be revealing as 5 of its 12 recorded member nations are considered to be in or at high risk of “debt distress” by the IMF, the other 7 holding “moderate risk.” What certainly does not help is the low inflationary environment of countries on the CFA franc, making it harder to pay back debt.

Instead, what arguably ought to be of focus for the sub-Saharan member nations, and perhaps developing economies as a whole, is boosting the domestic share of savings in order to enable greater investment capital in the long-term. Strengthening property rights, political governance, and economic and financial institutions would also go a long way in planting the incentives for domestic economic activity, in the process reducing the risk of swift collapse that may be found with a larger reliance on foreign investment. The needs of developing, sub-Saharan African economies differ greatly from that of the developed eurozone.

While the idea of more stable and lower inflation may sound attractive to the developing Franc Zone, it ultimately may come at the expense of short and long-term economic growth. In the short-term, central banks need to respond to domestic shocks in their bid to secure sustainable economic growth, and sub-Saharan economies are heavily dependent on the cheap exportation of commodities. In the long-term, the overvaluation of the CFA franc comes with an opportunity cost: the discouraged diversification of the Franc Zone’s export sector as well as a greater foreign share (and more importantly a declining domestic share) of total investment leaves the currency union on shakier ground. As protests against the currency heighten, however, the CFA franc’s remaining days could prove to be numbered.

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