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Africa And Aboriginal Tuesdays: The IMF Moves Against West Africa's Monetary Union

The controversy over the International Monetary Fund's (IMF) expressed concerns over Nigeria's participation in a single-currency West African Monetary Union again raised the subject of the multilateral institution's persistent meddling in African monetary policy mattters. Specifically speaking of the intended monetary union between the CFA Franc nations: Mali, Burkina Faso, Ivory Coast, Guinea-Bissau, Senegal, Niger , Benin and Togo with the ECOWAS nations of Ghana, Nigeria, Liberia, Sierra Leone, Gambia, and Guinea; an "anonymous" IMF expert reportedly said "The corruption in Nigeria, together with the country's tendency to engage in uncontrolled government spending, would make it an unsuitable partner,".

Nigeria's participation is key to the future prospects of the single-currency area.

The corruption and spending argument is a red herring that the IMF is using as part of its cover story to scare the countries involved away from Nigeria, as well as the idea that they have already settled upon - monetary unity.

But the IMF is able to gain a bit of traction and cause confusion with its smokescreen because the structure and method of union embarked upon by these nations is far from what it could be.

Noble as it sounds, the monetary union, as currently designed, would not permit West Africa to escape the horrors of its central banking history. The IMF seeks to take advantage of this reality by going off on a tangent about how Nigeria's terms of trade, fiscal policy and corruption make it incompatible for unity.

The points are not totally insignificant, but are all issues that can be more than adequately addressed while the basics of currency stability and arriving at the proper monetary regime are being taken care of. Africans, just like Europeans, can walk and chew bubble gum at the same time, if they please.

Last year my colleague Matt Sekerke and I offered a plan that we think can help solve the monetary problems in the region and which would allow the committed countries to escape and overcome the incomplete and disingenuous arguments presented by the IMF.

If the countries of West Africa can close their ears when the IMF is speaking and focus on their unique history with monetary policy and sound economic principles, they can develop a method to union and governance that could provide an important regional beachhead for the ongoing continent-wide efforts at economic integration. Interestingly, we have never heard the IMF say it was for an African Union, either.

Something to consider for those entertaining the body's criticisms of Nigeria juxtaposed to regional integration.

Cedric Muhammad
January 21, 2003


How To Create A Successful Monetary Union in West Africa

By Matthew Sekerke and Cedric Muhammad

February 18-19, 2002

Six West African countries - The Gambia, Ghana, Guinea, Liberia, Nigeria and Sierra Leone - have embarked on an ambitious plan to create a common currency, the eco, and a West African Monetary Zone (WAMZ). If all goes according to plan, the printing presses will run in September 2002, the six members' central banks will be merged into the new West African Central Bank (WACB) by January 2003, and the new union will be merged into the CFA Franc Zone by January 2004.

The transition to monetary union will be managed by the West African Monetary Institute (WAMI), which received its mandate on December 15, 2000 and began operations in January 2001. Its responsibilities are voluminous. These include harmonizing laws and regulations in the member countries, fostering cooperation between the members' central banks, establishing an appropriate interim exchange-rate mechanism, conducting and disseminating research on monetary policy issues, determining policies for convergence, promoting the development of a regional payments system, and educating the public about the features and value of the new currency.

The monetary policy rules of the future West African Central Bank, however, are anybody's guess. Indeed, the subject of monetary policy is allotted but one sentence in the WAMI's mandate: "The Institute will pursue appropriate monetary policy to ensure price stability and sustained economic growth in these countries as part of the overall ECOWAS integration effort." It is unclear, therefore, whether the new monetary union will pursue a quantity target (i.e., the growth of a specified monetary aggregate), an inflation target, an exchange rate target, or any combination thereof.

However, meeting even this broadly defined mandate would require the WAMI and WACB to be something greater - much greater - than the sum of its parts. Not one member country has been able to produce price stability or sustained economic growth. Growth has been elusive, in large part due to the lack of a strong currency. According to the World Bank's World Development Report of 2000/2001, the average annual growth rates from 1980 to 1998 of private consumption per capita have lagged far behind the rest of the world in WAMI member countries. In the cases of Nigeria and Sierra Leone, they have been strongly negative. The data are presented in Table 1.

Table 1

*There is little data available on Liberia due to the civil war which lasted from 1989 to 1996, which destroyed most of the statistical base.

The IMF estimates that production in 1996 was roughly 10 percent of the pre-war level. The Gambia's GDP growth has, conversely, been rather strong. Given Liberia's sharp decline, however, the net effect on the unweighted average of private consumption growth for WAMI countries is probably to push it lower than the -1.5 percent rate indicated.

Price stability has also been a pipe dream for these countries. Price stability can be measured in two ways: the rate of consumer price inflation - a measure of internal value - and the behavior of the exchange rate - a measure of external value. On these matters as well, the member states have had a poor record since establishing central banking. These data are presented in Table 2.

Table 2

Note: The depreciation of the Liberian dollar is based on a figure for end-2000. The others are calculated against the value as of February 6, 2002. All exchange rate depreciation is expressed as a factor, calculated vis--vis the US dollar. Cumulative inflation is through the end of 2000. Source: International Financial Statistics, World Currency Yearbook,, and authors' calculations.

A look at the data reveals that all WAMI countries have failed to issue currencies that are reliable stores of value. Admittedly, no currency is perfect; in the United States consumer prices have risen 532 percent since 1957, when the Bank of Ghana began operating, and the dollar, over that same time period, has depreciated from $35 to the current level of about $300 per troy ounce of gold. But with histories like these, why should anyone expect the currency issued by the new West African Central Bank to be any better than the cedi, the naira or the leone have been?

A plan for a successful monetary union in West Africa must take into account the experience of West African nations with central banking. Consequently, a new monetary union must be bound by rules that place monetary and exchange rate policies out of governments' reach. the six countries which will form the West African Monetary Zone - The Gambia, Ghana, Guinea, Liberia, Nigeria and Sierra Leone - have had poor records with central banking. Consequently, this history casts doubt on the success of any West African Central Bank. Indeed, these countries cannot escape their histories by simply creating a larger institution.

But let's assume that the slate is clean and the member countries simply concentrate on meeting their European Monetary Union-style convergence criteria. These criteria include:

A floor on foreign exchange reserves of at least three months of imports by 2000 and six months by 2003;

A ceiling on central bank financing of budget deficits to 10% of the previous year's tax revenue;

A limit of the annual inflation rate to a single digit in 2000 and 5% by 2003; and

A restriction of the budget deficit to GDP ratio of no more than 5% in 2000 and 4% by 2002.

The most problematic of these criteria is the floor placed underneath net foreign assets. Absent a strong inflow of foreign investment, a grant of foreign exchange from the government, or a nearly miraculous increase in exports, it is unclear how the central banks will augment their foreign exchange reserves. While foreign currency holdings may increase seasonally, those seasonal increases will be drawn down again as the season's proceeds are used to pay for imports, providing no net gain. The central banks could address this by making exports of foreign exchange illegal, but this would violate contracts and earn the banks little credibility.

Alternatively, the central banks could sell their domestic currencies on the open market to buy foreign currency. This would put downward pressure on the exchange rate and upward pressure on inflation, compromising the inflation target included in the convergence criteria.

And all of this doesn't even take into account the impossibility of simultaneously pursuing a domestic monetary policy of "disinflation" (that is, lowering inflation rates) while managing fixed exchange rates vis--vis the other countries within the zone. The dual pursuit of a monetary policy and an exchange rate policy amounts to a pegged exchange rate regime, much like those that have failed West African countries in the past, and, more recently, countries like Thailand, Indonesia, Russia, Brazil, and Turkey.

Does all this mean that a successful West African Monetary Zone is impossible? Fortunately, the answer is no. The member states can still achieve their admirable goals by establishing a West African Central Bank that would operate on a currency board rule. The new West African currency would be backed 100 percent by a reserve (also called an "anchor") currency such as the euro, and would be convertible on demand into the reserve currency at a fixed exchange rate. The currency board would not have a monetary policy, would not finance government deficits, and would not regulate banks or act as a lender of last resort. Inflation, as measured by traditional consumer price indices, would converge to US levels, as would interest rates. By pursuing an exchange rate policy without having a domestic monetary policy, a currency board constitutes a fixed exchange rate regime, distinguishing it from the traditionally problematic pegged exchange rate regimes.

Most importantly, a currency board would secure for West Africa one of the principal functions of money - a stable and clearly defined unit of account by which all forms of labor can be measured. Western Africa's policy makers should realize that it is not "price stability", as it is traditionally defined that they should be interested in, but rather the "law of one price" that should concern them most. The monetary authority would follow the law of one price by maintaining the price of the new currency in terms of the anchor currency. Doing so would provide a unit of account around which the regional economy could freely arrange prices of goods and services. By aiming at a stable unit of account, any monetary disruptions to the general price level would be avoided, securing price stability. This unit of account function of money has the effect of increasing the level of equality in a society, as the government is unable to manipulate the value of its currency in favor of one class of citizens over another.

To emphasize principle, each day, under a currency board regime, the balance sheet of assets and liabilities should be presented to the public, so that the citizenry, consumers and producers are aware of the soundness of the backing of the local currency. This would increase trust, an asset in any economy, and dispel any suspicions of manipulation on the part of the currency board.

And to guard against a deterioration of the anchor currency - as measured by a leading indicator such as gold - a model currency board law could contain a rule that contains very specific terms for switching to a new anchor currency. For example, if the dollar price of gold were to increase or decrease significantly, and remain at that level for over a year, the law would allow for a switch to another currency as a new anchor. The new reserve currency would, of course, have to perform better than the old, along the same criteria, in order to assume and maintain the anchor currency position.

Four West African states - Ghana, Nigeria, Sierra Leone and The Gambia - were part of a West African Currency Board from 1913 until the establishment of their respective central banks. The Currency Board preserved a fixed link to the pound sterling through two World Wars and the Great Depression. During this time inflation was low and growth was high. As just one example, per capita GDP in Ghana doubled from 1913 to 1960, an annual growth rate of roughly 1.5%.

Why did these countries leave the currency board? Principally for two reasons: first, the influence of nationalist arguments made by Africans heavily influenced by socialist and communist teachings and rhetoric - which were easily accepted by those who despaired of inadequate access to credit; and second, the victory of the theoretical argument advanced by the International Monetary Fund and some independent economists that central banks represented the ultimate monetary regime.

But central banks, since the independence era, have certainly not improved things where the access to capital and credit argument is concerned. Nominal lending rates are now, for example, as high as 56 percent in Ghana, compared to the 12.5 percent mortgage rate that prevailed in the early 1950s. Unsubsidized long-term lending in local currency at fixed rates, available during the currency board era, is no longer available. Consequently, the cost of financial capital is higher today than it was in the colonial era. As for the double hurdle of crony capitalist and race - oriented discriminatory practices that many Africans point to as barriers to access to credit, a currency board regime could help to overcome the existence of such, by its delegation of credit creation to members of civil society, specifically, merchant and investment banks, credit and savings associations, and even micro-lending institutions. These entities could more than adequately develop liquidity for the regional economy as these institutions intermediate savings and generate credit through the issuance of shares and/or subordinated debt instruments.

Both West Africans and international investors could freely create, own and operate such institutions with success and profits, addressing skepticism that only foreign financial capitalists would benefit from credit creation. And if property rights issues can be peacefully resolved (in a leading West African nation like Nigeria, for example) financial intermediation could become a very lucrative undertaking in West Africa, as titles to land and other assets could serve as collateral for bank loans.

Currency boards have a strong record in general, and in West Africa in particular. By operating on a currency board rule, the West African Central Bank could create a strong regional currency that would satisfy its goals of achieving price stability and providing a foundation for growth. Without a currency board rule, the West African Central Bank has little chance of accomplishing either goal.

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Tuesday, January 21, 2003

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