Africa Finance Forum
What is the best way to provide monetary arrangements for Africa, and what are the optimum currency areas in the continent? The question is particularly relevant at the moment as Africa considers a continent-wide currency system, while the Euro – the major example of a monetary union for African politicians to observe – undergoes stresses and strains arising from the incomplete way it was constructed.
What can be learnt from previous monetary unions, whether in Africa (East African Shilling, for example) or elsewhere? Why do the Central African Franc zones in Francophone West Africa work, and why is no similar arrangement likely between the English-speaking states of that region? Why does the Rand Monetary Area work and why is Botswana not a member of it? Should the smaller countries and economies of Africa be trying to maintain an independent currency and what welfare is gained and/or given up as they do so? These are all live issues where opinion formers should be contributing to the political dialogue in Africa, but where there is a need to have a sound understanding of the issues to do so.
The advantages of a monetary union are well known. A monetary union can promote trade, and can encourage regional competition both within and between members of the union. It reduces costs associated with currency conversion and exchange rate uncertainty. It creates a larger and therefore potentially deeper and more resilient banking sector for the common currency, and it offers economies of scale in central banking and opportunities to optimise monetary policy.
But there are also disadvantages in a monetary union, especially if the member states enter it at different stages of development or fiscal and monetary maturity. Apart from the well-publicised challenges of finding a single monetary policy to suit all members, monetary unions can face challenges if member states have differing optimal inflation rates, or face the possibility of asymmetrical external shocks. Member states may also enter the union with greatly differing fiscal positions, both accumulated debt and budget deficits, and it may be difficult to harmonise and control the member governments’ budgetary positions for the common good. More subtle issues include the danger of “free-riding”, in which weaker member states use the credibility of the monetary union to pursue sub-optimal policies or avoid reforming their economies, and there is always the risk of trade diversion – the monetary union as a whole becoming a more closed economy, trading with itself out of convenience and thereby stagnating, instead of developing external markets and remaining open to new ideas.
In general, monetary unions seem to work best when the member states are open economies with well-diversified export bases and good labour mobility both within and between the member states, and when there is a political commitment that goes beyond sharing just monetary sovereignty to underpin and bolster the monetary structure. It also helps if the larger member states at least have a record of low and stable inflation. But for a significant number of African countries, these conditions are still an aspiration rather than a well-embedded fact: many for example are still building their internal labour markets, and labour mobility between states is very limited.
In assessing which areas are ripe for monetary union in Africa, it is important to recognise that monetary unions can take different forms. Some consist of smaller countries borrowing the currency, and so credibility, of a larger more developed country (which may or may not be a physical neighbour). The Rand Monetary Area is a very good example of this type of monetary union, and, in general, such unions work because the large anchor country can maintain a competent currency for the benefit of all members. But in Africa, there are few other potential cases for this type of union.
Other monetary unions consist of countries bound together politically through common links to and support from a third country. The CFA zones in Francophone Africa are an example of such unions, drawing on common heritage and links with France, but here again there are few other potential cases for this type of union.
Finally, one has monetary unions as part of an ongoing political process of union between sovereign states. These are the most difficult types of monetary union to create and sustain; it can be done, witness the unification of both the political states and the monetary systems of Italy and Germany in the 19th century in Europe, but when such political unions break, so very quickly do their monetary unions – as the fate of the Soviet rouble, the Yugoslav dinar and the Czechoslovak koruna, the common currency of the Czech Republic and Slovakia, show.
There is therefore much to think about in constructing a monetary union. There are considerable advantages, but also risks, and a poorly constructed union may be worse than no union at all, and may even set back the wider ambition of a greater political union for Africa’s many and diverse communities. The dream of monetary union is attractive, but politicians may do well to move slowly: to build in haste may be to repent at leisure.
John Nugée is a Senior Managing Director and head of the Official Institutions Group at State Street Global Advisors, a full service asset management firm.