Increasing international economic and financial integration has created opportunities for growth and development, but it has also made it easier for crises to spread from one country to another. For instance, currency speculation against the British pound and a few other European countries before the establishment of the common currency in 1992 nearly caused the collapse of the monetary arrangements in Europe, and inflicted high costs to growth prospects of the area.⁽²⁾

Financial crises are not new, but the way they develop and spread continues to evolve with the world’s financial and economic integration. In some instances, they are an almost predictable result of inconsistent or unrealistic macroeconomic policies, but in other cases, countries with fundamentally sound policies have been pulled into a crisis for no obvious reason. This makes these disturbances of the financial system difficult to predict, but it also increases the value of a set of early warning indicators. The contagion effects of a crisis do not conform to a single pattern and they reinforce the idea that there are different types of crises with their own rules of behaviour.

However, the financial dire straits in the Eurozone are characterised by a rocketing of prices of assets, a very long period of credit expansion and consequently an accumulation of official debt. The Eurozone economic crisis is likely to put the West Africa Monetary Union’s (WAMU) economy in a deep economic downturn by affecting the evolution of import from and export to the European Union (EU) member countries, while also affecting the direct investment prospects from the EU, the relative borrowing capacity and the growth prospects of the WAMU member countries.

According to Standard & Poor (S&P), most European countries are officially in recession characterised by economic stagnation and debt crisis. Africa will probably face uncertainties over its growth and development prospects. An S&P issue credit rating is a current opinion of the creditworthiness of an obligor with respect to a specific financial obligation, a specific class of financial obligations, or a specific financial programme (including ratings on medium-term note programs and commercial paper programs). It takes into consideration the creditworthiness of guarantors, insurers, or other forms of credit enhancement on the obligation and takes into account the currency in which the obligation is denominated.⁽³⁾

In evaluating the capacity and willingness of Eurozone countries to meet their financial commitments as they come due, and may assess terms, such as collateral security and subordination, S&P has degraded the notes for some countries making it difficult for them to borrow. In this way, France for instance has lost its AAA to be degraded to AA, making it harder for it to pay cumulated debt and meet its financial obligations than before.

Surely the current financial and economic crisis in the Eurozone might affect Africa’s growth drivers and growth prospects by causing a sharp decline in foreign demand for the WAMU domestic commodities and prices, and decline of capital inflows to the WAMU member countries. Also promises of increased aid and investment have not yet materialised.

In a difficult international and European business environment with such observed magnitude, is the WAMU able to generate the necessary resources for development and poverty reduction?

The impact of the Eurozone crisis on the borrowing capacity of the WAMU countries

It is almost certain that the persistence of the financial crisis in the Eurozone group will impact the flow of foreign direct investment (FDI) to the WAMU area. FDI-driven policy has been the centre of the policy for all member states. For some countries of the area, the flows of investment have been positive since 2007. The shares of investment to gross domestic product (GDP) are important for Benin (4.7%) and Burkina Faso (5.1%). But this share has decreased drastically for counties like Senegal, Mali, and others. With the Euro area being crippled with debt burdens ranging from 84% of GDP in some countries and 162% in others, the investment prospects and the borrowing capacity of WAMU member countries will be affected.⁽⁴⁾

Current FDI inflow to Africa is constant and relatively low, but there are large statistical discrepancies between countries as to their different borrowing capacities and investment infrastructures. However, in the short term, the financial and economic crisis of the Eurozone is expected to cause FDI declines in 2012 and 2013. Economic Community of West African States (ECOWAS) member countries will be severely hit if commodity prices continue to display dramatic drops. This causes greater isolation for the WAMU zone, which depends heavily on foreign capital.

The impact on the trade flows in and out of the WAMU

Most often the global economic crisis has been transmitted to Africa primarily through reductions in export revenues and remittances. The deceleration of the Eurozone economy caused by a rising public debt and financial crisis is to cause a fall in the prices of raw materials, impacting consequently on export revenues, current business transactions, and other drivers of economic growth in the WAMU area (such as inflow of capital and FDI from the Eurozone member countries).

The occurrence and persistence of the Eurozone financial crisis may affect the evolution of the trade flows for the WAMU member countries. The current dependence of trade balance of countries on European transaction is likely to deteriorate in the absence of strong economic drivers such as sound macroeconomic reforms and decreased capital inflows. Most countries that recorded trade surpluses because of increased commodity prices in the past years, such as Cote d’Ivoire, Mali, and Senegal, are likely to register deficits due to drops in prices and fall in FDI inflow.

For instance, Benin’s exports were 20.5% of GDP and imports 31.3% of GDP; Cote d’Ivoire accounted for exports and imports respectively a share of 47.6% and 31.9% of GDP; Burkina Faso accounted respectively 8.6% for exports, and 19.6% for imports, as of GDP. The overall trade balance prospect is likely to be identical in the other countries of the WAMU area, characterised by a trade balance deficit, especially in commodities, and a sharp drop of foreign demand for their export goods. Furthermore, the decrease in the household income in the Eurozone is likely to cause a slowdown in the tourists’ flows, leading to a degradation of the balance of services, and consequently the current account balance.⁽⁵⁾

Most commodities exchanged with the Eurozone markets come from extractive mining industries, agriculture and forestry, and such other primary sectors. Cotton accounted for 65.2% of export in Burkina Faso, gold for 72% in Mali, cocoa for more than 20% in Côte d’Ivoire, uranium for 30.0% in Niger, bauxite and gold respectively for 39.2% and 31.7% in Guinea. Imports mainly relate to food products, oil derivates, and also technological products. The future outlook of the financial crisis in the Eurozone is likely to worsen. Foreign demand for primary goods from the WAMU countries is also likely to keep falling.

Lessons from other Euro-pegged currencies

An interesting issue to be debated is that as the Eurozone crisis critically deepens, what will happen to the CFA? Eight agrarian West African nations use the euro-pegged CFA as their legal tender forming in this way the WAMU; CFA is the currency of eight West African countries known as Benin, Burkina Faso, Côte d'Ivoire, Guinea-Bissau, Mali, Niger, Senegal and Togo. Like the EU, the CFA zone is economically, politically, and culturally diverse. It encompasses several million people, hundreds of languages, and a patchwork of ethnic groups. Some or all of them have been hit with political tumult since they gained independence in the 1960s. And yet, the space’s essential monetary infrastructure remains. Some might credit the legacy of French colonial rule for keeping the CFA together, given Paris’s backing of the currency and guaranteeing of the euro exchange rate. This peg undoubtedly garners benefits for the CFA (e.g., lower transaction costs in trading with EU countries), but its fate is not intrinsically tied to the euro.⁽⁶⁾

If the euro collapses, the CFA zone would not tie itself to a resurrected French franc, but likely peg to a basket of currencies. Low-growth Europe is no longer the prominent destination for CFA goods, rendering the euro peg less and less important. In 1995, approximately 49% of exports from the central African CFA countries were bound for Europe. By 2010, that number had dropped to an estimated 32%.⁽⁷⁾

China’s rise as an export destination is the most responsible factor for the turn away from Europe. It has an insatiable demand for natural resources, which make African countries attractive trading partners. One unique feature of this cycle was that the savings surpluses of the South, mainly through the current account surpluses of China, the other Asian economies and the oil-based economies, would boost the growth prospect of ECOWAS if the member countries wish to diversify their trading partners and investment portfolios.

However one major consequence of the crisis is that, without the backing of the French Treasury, including the mandatory reserve balances, the CFA zone would no longer have the immediate credibility and resources that keep international investors relatively at ease with investments in highly-indebted poor countries. But the euro’s continued fall against the dollar signals that investors seem to be losing confidence in the euro itself. And, while boosting CFA zone exports, devaluation also comes at the expense of making imports into Africa more expensive. Oil exporters will benefit while harming crude oil importers and consumers of foreign goods and services in general. For the most part, however, only a small segment of those in the CFA zone consume these goods and services given their relatively high costs. Beyond its economic role, the CFA zone has also shown to be useful in mitigating conflicts. A prime example being Ivory Coast’s 2010-11 election crisis in which the incumbent president in power refused to step down. The West African central bank shut down the president’s access to the country’s reserves, cutting off his resources to buy the loyalty of civil servants and security forces.

Perhaps seeing the CFA’s success, the East African Community (EAC)—the regional economic body comprised of Uganda, Kenya, Rwanda, Tanzania, and Burundi—has moved toward creating its own common currency. Progress has been halting but the countries will likely soon cede customs authority to the EAC and are hammering out a deal to stand up a monetary union centered on the envisaged “East African Central Bank.”⁽⁸⁾

Governments’ responses to the situation

Financial crises are not new to Governments in Africa. However, the way the situation is handled could vary from one country to another. But overall they all engage in macroeconomic policy reforms, fiscal cooperation, and trade liberalisation policies. At the core of their policies, WAMU member states engage in mobilising financial resources at country, regional and international levels to finance growth, development and poverty reduction programmes, investment infrastructures and training programmes.

In terms of macroeconomic policy, member countries must adopt fiscal discipline so as to promote macroeconomic stability at country level and sub-regional level. Lack of fiscal harmony may affect the economic activity leading to a decline in tax revenues, and ultimately the fiscal balance will deteriorate. In response, some countries will undertake expansionary fiscal policy to support domestic and external demand. There must also undertake tax administration reforms geared to increase the efficiency of the tax administration.

In the area of monetary policy, where measures aimed at reducing inflation rates should be implemented, there is an incentive for the monetary policy to be eased. In case prices (fuel and food) around the world are steadily and moderately decreasing, there is a disinflation movement in most of the WAMU member nations that would lead to an unnecessary intensification of strict monetary policy. Otherwise when inflation pressure remains high, and the pressure of the demand side persists, the monetary policy authority states that the central bank of the WAMU should tighten its monetary policy.

Additionally, the exchange rate fluctuation contributes to competitiveness and economic growth in case commodities prices decrease permanently. Therefore, the member nations of the WAMU should let the real exchange rate of CFA to depreciate so as to stabilize their economies.

Concluding remarks

Examining the effect of the economic and financial crisis experienced in the Eurozone on the WAMU’s economy through the pegged-CFA to the former French Franc and now to the Euro as a legal tender, one can notice that the member nations will undergo more or less the effects of the euro crisis. The demand for WAMU exports will tend to reduce, with migrant workers transfers falling increasingly. One way or the other, the investors’ aversion to risk will probably result in reversal of portfolios investment flows, discourage FDI inflow to these countries.

The persistent financial and economic crisis in Europe is likely to cause the results of the slight growth of the WAMU area that was achieved in the consolidation of macroeconomic variables. The implementation of credible macroeconomic policies and the diversification of trading and investment partners could greatly contribute to maintaining a stable macroeconomic situation.

Written by Youssouf Keita ⁽¹⁾

NOTES:

(1) Contact Youssouf Keita through CAI’s Finance and Economy unit ( finance.economy@consultancyafrica.com).
(2) Gerber, J., 2004. International Economics 3rd edition. Addison Wesley: Boston.
(3) ‘Impact of the Financial and Economic crisis on Africa’, African Development Bank Group, Working paper series Number 96, March 2009, http://www.afdb.org.
(4) ‘Impact of the International Financial Crisis on ECOWAS macroeconomic convergence criteria’, West African Monetary Agency (WAMA), June 2009, http://www.amao-wama.org.
(5) Miller, A.C, and Bouhan, N., ‘Africa's single currency, the CFA Franc, in a Post-euro Future’, The Christian Science Monitor, 19 January 2012, http://www.csmonitor.com.
(6) Ibid.
(7) Ibid.
(8) Ibid.