The Promise of a West Africa Currency Union
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- Authors: Eswar Prasad, VERA SONGWE
- Published: June 1, 2021
Overview and rationale
- A currency union encompassing all of West Africa promises benefits but faces a multitude of obstacles.
- Potential benefits listed:
- Improve trade and investment flows in the region.
- Bring added discipline to the macroeconomic and structural policies of member countries.
- Enhance stability against external shocks.
- A strong central bank could have helped the region better weather the economic effects of the COVID-19 pandemic.
- Serve as an anchor for inflation expectations and as a catalyst for labor and product market reforms.
- Exert external discipline on fiscal policies.
- The COVID-19 pandemic highlighted limitations in countries’ ability to mobilize large-scale fiscal and monetary responses (African countries called for a $100 billion stimulus but lacked the tools to finance such an injection of capital).
Current status and history
- ECOWAS leaders aimed to achieve a monetary and currency union by the end of 2020 but abandoned that timetable because the group was not ready.
- The emergence of the COVID-19 pandemic pushed any proposed union to the back burner for countries in the 46-year-old ECOWAS.
- Existing monetary arrangements within ECOWAS:
- Eight ECOWAS countries are already members of a currency union (WAEMU): Benin, Burkina Faso, Côte d’Ivoire, Guinea-Bissau, Mali, Niger, Senegal, and Togo.
- WAEMU members share the CFA franc, which is linked to the euro.
Major impediments to unity
- Heterogeneity across the 15 ECOWAS countries:
- Six of the fifteen can be classified as middle-income countries (with annual per capita income of at least $1,000, based on market exchange rates); the others are low-income countries.
- Nigeria accounts for about 67 percent of the ECOWAS GDP, while the five smallest members together total less than 2 percent.
- Three countries—Nigeria, Ghana, and Côte d’Ivoire—constitute about 67 percent of the 350 million people in ECOWAS, while six countries, each with fewer than 10 million people, together represent 7 percent of the ECOWAS population.
- Structural differences: oil exporters versus oil importers; reliance on agriculture and extractive industries versus presence of manufacturing.
- Asymmetric shocks and policy challenges:
- GDP growth and inflation do not move simultaneously across countries; terms-of-trade shocks are not symmetric.
- Example: changes in petroleum prices affect oil exporter Nigeria differently from oil importers.
- Loss of independent currency and monetary policy places significant burden on tax and spending policies for stabilization.
- COVID-19 and plunging oil prices affected Nigeria more severely than some other members.
- Technical, operational, and political obstacles magnified by diversity of economies; challenges would be greater for a broader pan-African monetary union.
Integration progress and reinforcing mechanisms
- Regional trade integration developments:
- African Continental Free Trade Area (AfCFTA) was formally ratified by 36 of the 54 signatory countries as of February 2021; it reduces tariff and nontariff barriers and gives Africa a common voice on global trade policy issues.
- ECOWAS measures: ECOWAS Trade Liberalization Scheme and the common external tariff (introduced in 2015).
- Persistent barriers: uneven tariff application and other restrictions on trade across borders.
- Risks from greater factor mobility:
- Unfettered financial flows can contribute to boom-bust cycles in property and other asset markets.
- Labor mobility can cause social and political tension.
- Suggested regional mechanisms:
- Effective regional mechanism for gathering macroeconomic and financial data.
- Multilateral surveillance to cross-check policy stances of ECOWAS countries.
- A risk-pooling mechanism among members to deal with external shocks (commodity price shocks and unique events such as the COVID-19 pandemic).
Alternative approaches and lessons from other regions
- Consideration of alternatives to full monetary union:
- Regional trade and financial arrangements that preserve monetary autonomy (as in Asia).
- Regional risk-sharing mechanisms such as the Chiang Mai Initiative, which include pooling of foreign exchange reserves.
- Europe’s experience:
- Euro area benefited trade and investment flows but also experienced economic and political tension, especially from large net fiscal transfers and differing banking regulations.
- Caution against moving hastily toward a currency union without addressing institutional and fiscal frameworks.
- Open question: whether trade and financial agreements can serve as precursors to a more durable and resilient ECOWAS currency union.
Institutional and policy prerequisites for a durable union
- Areas identified as necessary or beneficial:
- Macroeconomic convergence, especially similar levels of inflation and sufficiently low public-debt-to-GDP ratios.
- Strong institutional frameworks and harmonized regulations on current account and capital account transactions.
- Regional payment system integrated with domestic and global systems to expedite cross-border settlements.
- Harmonized banking supervision and regulation that addresses institution-specific and systemic risks.
- Regional financial market development and integration (government and corporate bonds, money markets).
- Increased financial inclusion via traditional and new technologies (such as mobile banking).
- Consideration of a banking union and a unified financial regulatory system as part of a broader economic union.
Policy recommendations and steps forward
- ECOWAS leaders must weigh significant costs, operational issues, and transitional risks of a currency union.
- Key policy steps highlighted:
- Decide the appropriate level of economic union necessary to support monetary union stability.
- Build resilient policy and institutional frameworks that create positive benefit-risk trade-offs.
- Pursue regional financial market development and integration and increase financial inclusion.
- Consider regional risk-sharing and data-surveillance mechanisms before or alongside monetary integration.
- Long-term view:
- A single ECOWAS currency would be a major and ambitious undertaking with many potential benefits if accompanied by robust institutional support.
- The COVID-19 pandemic has reignited discussion about monetary instruments and is likely to generate renewed interest in the African Monetary Fund.
- The lessons of the ECOWAS experience will be invaluable if such an agency becomes a reality.
Article by Eswar S. Prasad and Vera Songwe, F&D Magazine, June 2021.
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