## The Promise of a West Africa Currency Union

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**Canonical URL:** [The Promise of a West Africa Currency Union](https://www.imf.org/en/publications/fandd/issues/2021/06/future-of-west-africa-currency-union-prasad-songwe)

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## Bibliographic details
- Authors: Eswar Prasad, VERA SONGWE
- Published: June 1, 2021

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### 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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_Source: https://www.imf.org/en/publications/fandd/issues/2021/06/future-of-west-africa-currency-union-prasad-songwe_