Regional financial integration and monetary coordination in the West African Monetary Zone and the East African Community
By Calvin Manduna and Olumide Abimbola
Source: The Economist
Achieving regional financial integration and a regional monetary union are long-standing ambitions for most African regional economic communities (RECs) and elsewhere in the developing world. For example, late in 2013, leaders of the East African Community (EAC) agreed to establish a monetary union within 10 years. Similarly, the 15 members of the Economic Community of West African States (ECOWAS) agreed on a roadmap to establish a shared currency known as the “Eco” by 2020. The Eco is to be preceded by the West African Monetary Zone (WAMZ), which is set to be launched by 2015 with the establishment of a Central Bank and common currency for the six WAMZ countries – Gambia, Ghana, Guinea, Liberia, Nigeria and Sierra Leone. The launching of the WAMZ will complement the already established eight-member West African Economic and Monetary Union (UEMOA), which shares a common currency, the CFA franc, that is pegged to the euro with a fixed exchange rate (€1:655.957 CFA franc).
There are both benefits and costs to monetary unions. In theory a monetary union makes trading and borrowing easier and cheaper for member countries. However, it involves a certain loss of economic sovereignty that comes with having a common currency and monetary policy. This means that individual countries cannot elect to print more money if they desire to or use interest rates to influence their economies. These monetary policy tools become the preserve of the regional central bank. Another negative for countries is the loss of tariff revenue from the emergence of a single or common market. In West Africa, tariff revenues can account for as much as 40% of tax receipts for some countries.
Scholarship on the viability of monetary unions and the best means to achieve a monetary union remains divided. The Eurozone crisis, which began early 2009, highlights some of the problems presented by that type of integrated structure. Several economic studies have concluded that monetary union would be good for the ECOWAS region, but are not unanimous on how to attain this objective. Some favour a rapid transition to minimise confusion and the risk of countries pulling back before the process is complete. Others advocate more gradual convergence to avoid economic shocks – which is a view advocated by the IMF in its recent advice to the EAC to proceed with caution.
Wading into this debate, the African Development Bank’s NEPAD Regional Integration and Trade Department (ONRI) recently published a Study on Challenges towards Regional Financial Integration and Monetary Coordination in the West African Monetary Zone and the East African Community. Integrating Africa blog editors Calvin Manduna and Olumide Abimbola sat down with the author Gabriel Mougani to discuss the study’s objectives and some of its major findings:
Question: What were some of the key focus areas for this study?
Gabriel Mougani: The report focuses on addressing the challenges towards financial integration and monetary coordination in the West African Monetary Zone (WAMZ) and the East African Community (EAC). These challenges include some minimum prerequisite conditions such as an adequate degree of trade and economic integration which means a well-developed regional infrastructure and the removal of barriers to intra-regional trade, a relative similarity of supply and demand shocks and business cycles, and a relatively advanced financial system and market integration. Another key requirement is a synchronization of key convergence criteria (such as the inflation rates that should not exceed 5% in EAC and 10% in WAMZ and the budget deficit excluding grants to GDP ratio that should not exceed 5% in both regions). Despite some progress, most of the countries in both regions do not comply with the macroeconomic convergence criteria set in the respective regions. Moreover, the different degrees of development of domestic financial systems have not contributed to accelerate the process of financial integration in both regions. These conditions have to precede the establishment of a monetary union and the introduction of a single currency. Thereafter, the report made concrete proposals aimed at sustaining the monetary coordination and financial sector integration process with a view to building a monetary union in both sub-regions.
Q: Why did you choose to focus on the West African Monetary Zone (WAMZ) and the East African Community (EAC) and what did you find is the level of progress in financial and monetary integration in those two regions?
GM: We wanted to assess the ongoing monetary coordination and financial sector integration processes, as preliminary stages towards monetary union in both the WAMZ and EAC, which actively engaged preparations with a view to building a monetary union, in light of theory and past experience.
We selected those two regions because they exhibited the following critical factors: (i) a limited number of Member States, which should facilitate the process, (learning from the Eurozone experience); (ii) the existence of strong political commitment, legal and institutional reforms; (iii) the existence of macro-economic convergence criteria; (iii) the progressive integration of the financial sector; (iv) the existing degree of trade and economic integration; (v) the existence of regional institutions involved in the monetary integration process; and (vi) the existing strategy for transition towards a single currency.
Our overall assessment is that unrealistic schedules, which inevitably lead to the postponement of deadlines, can undermine the credibility of the monetary union, and considerably weaken the support of market participants and the public, which is necessary for the entire process. Consequently, both regions (EAC and WAMZ) should adopt a realistic, pragmatic and gradual approach to conducting the financial and monetary integration process. The report has suggested a few concrete solutions that contribute to fostering the integration process in both regions.
Q: What other cautionary lesson(s) can we learn from the Eurozone experience in recent years and the way they have managed their financial and monetary integration process?
GM: The European sovereign debt crisis reflected the difficulties for some Eurozone member countries (e.g. Greece) to re-finance their government debt without the assistance of third parties. The crisis resulted from a combination of intricate factors, including the fiscal policy choices related to government revenues and expenses. The structure of the Eurozone as a monetary union without fiscal union contributed to the crisis and harmed the ability of European leaders to respond. The Eurozone example shows that the establishment of a monetary union is facilitated when there is prior monetary coordination and macroeconomic convergence. Therefore, the Eurozone model should motivate African RECs to adopt a cautious and gradual approach towards monetary union by fulfilling some minimum prerequisite conditions. Therefore, on the one hand it has been demonstrated that the adoption of a common currency has fostered European economic integration and provided many European countries with the benefits of low inflation and some degree of financial stability. However, the Eurozone crisis has also threatened to disorganize the European monetary integration model that Africa sought to imitate. The Eurozone crisis is a vital case study for African RECs, in particular for the EAC and WAMZ partner states as both regional blocs progressively move to unveil a monetary union.
Q: The AfDB has been very active in supporting regional financial and economic integration across Africa, for example in COMESA, and also the development of financial markets. What are some of the areas that you identified where the Bank could provide further support?
GM: The report outlined potential areas for intervention by the AfDB and other development partners. These areas, which relate to monetary integration strategy in general, financial infrastructure, and financial institutions and policies, are categorized within four broad categories: (i) Policy Action Frameworks, (ii) Capacity Building/Governance, (iii) Advocacy, and (iv) Finance.
Q: Further south, we have a form of monetary union with a unified monetary policy that is already active in the Southern African Customs Union (SACU), excluding Botswana. The participating SACU countries have retained their respective national currencies but are pegged to the South African rand as a regional anchor currency. How does this common monetary area under SACU differ in approach and effectiveness from what you observed in WAMZ and the EAC?
GM: First of all, the three regions have key similarities, namely a limited number of Member States, which should facilitate the monetary integration process (learning from the Eurozone experience). Also, there is the presence of a dominant economy at the regional level: South Africa accounts for about 95% of the SACU’s gross domestic product (GDP), Nigeria accounts for about 90% of the WAMZ’s GDP and Kenya contributes about 40% of the EAC’s GDP). Unlike EAC and WAMZ, SACU by itself has no criteria for evaluating macroeconomic convergence – a key prerequisite for realising a monetary union. However, despite the substantial divergence in the size and structure of SACU economies, there is a strong convergence in key macroeconomic variables such as inflation, debt levels, and reserve holdings – much of which is facilitated by the high level of monetary policy convergence already at work within the Common Monetary Area (CMA).
The progress achieved by SACU raises the question whether the SACU approach can be used by WAMZ and EAC as an intermediate stage to further advance their monetary coordination (and subsequently facilitate monetary integration). In this case, for example, the Nigerian naira would be used as a regional anchor currency in WAMZ while the Kenyan shilling will play the similar role in EAC. Further study is needed to determine whether the SACU’s approach may be feasible for WAMZ and EAC. On the other side, the SACU can learn from the WAMZ and EAC experiences. For this, it seems realistic and pragmatic that SACU should use the financial integration criteria formulated by the Southern African Development Community (SADC) if the sub-region wishes to implement a comprehensive monetary integration process.
Q: Finally, the attainment of an African Monetary Union and a common currency by 2021 is one of the objectives of the African Union (AU) aimed at boosting the continent’s competitiveness, intra-African trade and FDI. Do you see encouraging signs from your study that the building blocs towards the continental monetary union are starting to take shape?
GM: The African monetary union and common currency will offer to African countries several benefits. The common currency can be a catalyst for further economic integration on the continent by decreasing transaction costs, reducing costs associated with exchange rate uncertainty vis-à-vis partner countries, increasing price transparency between partners and promoting intra-African trade and investment. The single African currency will also reduce the risk of speculative attack on home country currency, and protect against domestic lobbies promoting exchange-rate manipulation or expansionary monetary policy.
However, a common currency implies some costs for the participating countries, including the loss of national sovereignty, the loss of ability to maintain an independent monetary policy, the loss of exchange rate adjustment flexibility to terms of trade, and other shocks. Given the EAC and WAMZ and other experiences on the continent in this area, the 2021 deadline seems ambitious. As stated earlier, unrealistic schedules, which inevitably lead to the postponement of deadlines, can undermine the credibility of the continental monetary union process, and considerably weaken the support of market participants and the public, which is necessary for the entire process. Even if this timeframe were feasible, there are still uncertainties about whether the benefits of a continental monetary integration outweigh the costs and whether a significant number of African countries will join this ambitious initiative.