20 July 2019 0 Comments

ECOWAS: an optimal currency area? P-2

 ”ECO must be NAIRA”

This post is the second piece of a discussion series on the opportunity of the creation of a common currency (ECO) for the country-members of the Economic Community of West African States (ECOWAS). In part 1, I described the economic rationale behind trade and integration and how the use of different currencies limit exchange opportunities between neighbors. In this second post, I focus more on the immediate incidence a common currency bears on local economies. First, I analyze the external position of the member states of ECOWAS specifically their current account in order to shed more light on the economic profile of the proposed monetary Union.  Next, I look at the public finances of the member states and nominal interest rates that apply to current short-term public treasuries with the goal of emphasizing how the new monetary zone would affect the cost of borrowing for each government. In the third post of this series, I will explore the institutions or mechanisms that have to be set up to ease up the transition and promote a successful currency area. I have to warn readers that the ensuing analysis focus primarily on Nigeria, Ghana and the countries in the West African Economic and Monetary Union (WAEMU) which have been sharing a common monetary unit (F CFA) from the dawn of their independence.

On the economic structure of ECOWAS country-members

The Economic Community of West African States (ECOWAS) is made up of fifteen countries with varying structures of economic activity. With around two thirds of the Gross Domestic Product (GDP) and more than half of the population of the Union, Nigeria represents its largest member, implying that the projected common currency will certainly inherit its core features from the Naira (Nigeria’s currency). Second, to Nigeria, comes Ghana, a country which has grown remarkably over the last two decades and tops the IMF charts of growth performance around the world in 2018.

Nigeria’s economy is dominated by services (53% of GDP) and Agriculture (22% of GDP) contrary to popular belief which entertains the myth that the country’s fortune is tied up to upheavals on the oil market. However, the country remains the largest oil exporter in Africa. This commodity makes up about 10% of its GDP but contributes more than 87% to its exports revenue.

As for Ghana, the economy seems to be more dominated by Services (56% of GDP), Industries (26% of GDP) and Agriculture (14% of GDP). Cocoa makes up about 1.2% of output and oil represents about 5.6%. These statistics highlight the misperception present in media covers which give the impression that the recent growth success of Ghana and Nigeria has been driven by Oil. Nigeria generally runs a surplus in its current account (due mainly to a positive trade balance) while Ghana tends to be more of CA deficit economy. Combined, these two countries make up about 75% of the GDP of the Union.

The other major player of the Union is made up of the eight countries of the West African Economic and Monetary union (WAEMU) which already share a common currency (F CFA) and represent about 20% of the GDP of the Union. Economic structures differ substantially within this group. If Agriculture and Services seem to be the main drivers of production, the major sources of external currencies (foreign trade) vary. Cocoa and Coffee dominate in Ivory Coast, Pineapple in Ivory Coast and Benin, Cotton in Mali, Burkina Faso, Benin, Ivory Coast and Togo, Cashew Nuts in Ivory Coast, Bissau Guinea and Benin and Peanuts in Senegal. Niger is a major Uranium exporter while Mali and Burkina Faso export a significant amount of Gold. Ivory Coast exports Oil, while Senegal and Togo export Phosphates. With regards to the Current Account, most countries in the Union run a deficit (due to a negative trade balance) except Ivory Coast which ran a trade surplus for several years.

The Foreign sector of the Union

The foreign sector of the ECOWAS Union is dominated respectively by Oil (Nigeria, Ghana and Ivory Coast), Cocoa and Coffee (Nigeria, Ghana and Ivory Coast), Cotton (Mali, Burkina Faso, Benin), Gold (Ghana, Mali, Burkina Faso), Uranium (Niger) and Phosphates (Senegal and Togo). None of these commodities is large enough to drive economic trends in the Union. Oil which is certainly the largest commodity export of the Union represents about 10% of GDP in Nigeria, 5% in Ghana and less than 3% in Ivory Coast. However, these commodities will drive movements in the exchange rate of the projected common currency since Oil and Cocoa will certainly make up a large portion of the exports in the Union. In contrast, although commodities such as Cotton and Uranium make up the lion share of the exports of the associated countries, they will not probably be influential in the value of the common currency given the economic size of the producers. Service exports on the other side are quite limited and dominated by tourism for which countries like Senegal and Ghana draw important resources….

The value of Eco and the Current Account of country-members

Nigeria will probably not experience any dramatic effects of the new currency on its external accounts but other members of the Union might. Eco will probably inherent its value and other fundamentals from the NAIRA due to the size of Nigeria in the Union (around 70% of GDP). For other economies in the Union, purchasing power parity (PPP) with regards to Nigerian prices will determine how the new currency affects the competitiveness of local economies. For instance, most of the countries currently using the F CFA are poorer than Nigeria with domestic purchasing power lesser than what it is in Nigeria. This simply means that for tradable goods (think of imported rice), prices of identical commodities are probably higher in Nigeria relative to other countries of the Union. Economic theory defends that nominal exchange rates should reflect price ratios between economies (law of unique price) and if as expected the value of the ECO currency is tied up to the Nigerian economy, these countries might experience an inflation bump immediately after the adoption of the currency. For Nigeria, the new currency will be beneficial in the sense that it will certainly take monetary policy away from domestic actors and move it into the hands of a multilateral regional institution. This could open a new area of monetary stability and low inflation to a country that has witnessed several episodes of rising price levels over the last couple of decades. In sum, I expect the new currency to boost up prices and costs of living in other economies in the Union in the immediate aftermath of its inception. For large exporters such as Ivory Coast and Ghana, this development could dampen local productivity for a while. However, the adjustment process to a new equilibrium should not last long but could take anywhere from a few months to a couple of years.

ECO, Public Finance and Interest rates on public treasuries

One key transformation that will result from the adoption of a common currency is the convergence of the interest rates on public treasuries. This could have a significant impact on the deficit, debt and the public finance of member states. Economic theory through the Uncovered Interest Parity (UIP) defends the “Trifecta” Hypothesis. This notion refers to the consideration that the policy space of a state is limited in a world with perfect capital mobility. In other words, when there is no impediment to the free flowing of financial assets, monetary authorities cannot set interest rates and expect to manipulate their nominal exchange rates at the same time. In a currency area, given that exchange rates are set by a common authority for all member states, it follows that interest rates will also have to converge assuming perfect mobility of financial assets. If interest rates have to converge, they will certainly align to the rates on Nigerian Treasuries. But how will that affect the public finance of other member states?

At the present, there is some variation in the nominal yields on public treasuries across countries in the Union reflecting varying levels of inflation. In 2019, the average rate on short-term Nigerian treasuries (maturity less than a year) varies between 11% and 13% with an associated inflation rate of 11.3% in February 2019. This implies that the real interest rates on short-term Nigerian public securities amount to less than 2% and turns actually negative for some securities. In comparison, Ghanaian short-term public treasuries yields belong to the range 14-15% with an associated inflation rate of 9.2% in February 2019, implying a real interest of 5-6%. For countries in the WAEMU that share the F CFA, inflation rates are modest and below 2% in 2019 for most countries. Interest rates on short-term public treasuries do not vary much and range between 5% and 6%. Senegal, Ivory Coast and Benin have all issued Eurobonds on international markets over the last couple of years, with respective nominal rates of 4.75%, 5.25% and 5.75% on short-term securities. The real interest rates on public securities within the WAEMU group belong to the interval 3-4%.

All these considerations point to the conclusion that the convergence of real interest rates might benefit all country-members by lowering the cost of borrowing for public authorities. For Nigeria, it is expected that the adoption of a new plausibly more independent Central Bank will shield monetary policy from domestic influences and lower inflation going forward. This will lower nominal interests on Nigerian public securities. For other members, the alignment of interest rates to the Nigerian benchmark should also lower borrowing costs for governments and release budgetary pressure on other priorities. In a third post, I will discuss the types of multilateral institutions and arrangements that ought to be set up to ease up the transition on member-states and promote a long-lasting successful currency area.


ECOWAS: Economic Community of West African States (15 country members)

WAEMU: West African Economic and Monetary Union (8 country members using the F CFA)

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