A second Devaluation of the CFA Francs… Worrisome Prospect

By Hinsley Njila for The Chia Report
Recent persistent and unchallenged rumors about the imminent devaluation of the CFA Franc have left many who do business and/or hold long cash positions in Central and West Africa unsettled about the potential consequences to their interests. In the November 22nd issue of the Frontier Telegraph, Dr. Gary Busch alleges that the agreement to devalue the currency has already been reached by the Africans and the French. Furthermore, he alleges that Alassane Ouattara has been dispatched to make the rounds to all 14 CFA zone member countries to help them prepare for this eventual change. 

We cannot independently verify the allegations by Mr. Busch, but it is prudent for us to analyze the situation in support of the interests that we protect in the region. In this article, I will offer a few explanations to the untrained economist  as to the how and why a currency gets devaluated.  I will talk about how central banks fix exchange rates, and with Cameroon being my focus, I will relate some of the lessons of devaluations in Mexico in 1995 and Thailand in 1997 to enhance my advice to the central government.

How and why does currency devaluation occur?
Devaluation is the reduction in the value of a currency toward goods and services, or with respect to the value of other currencies with which the currency can be exchanged. Stated in other words, devaluation occurs when the central bank raises the domestic currency price of foreign currency.

  

 

Whenever there is the perception that devaluation is imminent, this may lead to speculators ditching local currency for foreign reserves, in turn increasing pressure on the issuing country to actually devalue. Without perfect information, speculators will often continue buying foreign reserves, which ultimately lead to balance of payment issues. This phenomenon is what happened in Mexico in 1994 as Paul Krugman and Maurice Obstfeld wrote in ‘International Economic’ (2000) where the real exchange rate ultimately became equal to the nominal exchange rate and the currency fell very rapidly.

Devaluation can help do three main things

 

• Allow governments to fight domestic unemployment despite the lack of effective monetary policy.
• Resulting improvement in the current account, something that the government may find desirable.
• Lastly, to affect the reserves of the central banks if they are running low.

Currency would also be devalued in an environment where inflation rises quite rapidly because a Central bank in cahoots with a government is printing money to cover government expenses rather than borrowing.

How Central Banks Fix Exchange Rates
No analysis of the problems of West and Central Africa would be complete without taking into account the implications of fixed exchange rates. The CFA has been pegged to the French Francs since 1948, and during its history it has been devalued once in 1994 – CFA50 to CFA100=FF1. The responsibility of converting CFA to Euros has always been guaranteed by the French Treasury without any monetary policy implications for the Bank of France and ECB. Although BCEAO and BEAC maintain an overdraft facility with the Bank of France, their withdrawal limits were set in 1973.

Each CFA central bank must keep at least 65 per cent of its foreign assets in its operations account with the French Treasury; provide for foreign exchange cover of at least 20 per cent for sight liabilities; and impose a cap on credit extended to each member country equivalent to 20 per cent of that country's public revenue in the preceding year.  Since 1999, the CFA/Euro exchange rate was fixed at CFA665.957 = EURO1.

Central banks succeed in holding exchange rates fixed only if financial transactions ensure that asset markets remain in equilibrium when exchange rate is at its fixed level. The process through which asset market equilibrium is maintained is often illustrated by the model of simultaneous foreign exchange and money equilibrium. Krugman and Obstfeld have a theoretical illustration of the Money Market Equilibrium under a Fixed Exchange Rate environment.  They stipulate that to hold domestic rate at R*, the central bank’s foreign exchange intervention must adjust the money supply so that R* equates aggregate real domestic money demand and the real money supply: Ms/P = L(R*,Y). When exchange rates are fixed to a value say E0, market participants always expect it to remain fixed through the intervention of central banks.

Lessons from Thailand and Mexico
In their detailed analysis of the emerging market crisis that started with Thailand’s devaluation in 1997, Krugman and Obstfeld came up with very clear, easy to understand lessons learned.  Of all the lessons they pointed out, we identified 3 that are most relatable to the situation in Cameroon, and we address those below:

1) The central importance of banking
I am a little concerned that if this rumor is left unaddressed, speculators at some point may trigger a bank run. If this should happen, one can conceivably see a scenario where in the short run the government may be conflicted between restricting the money supply to support the currency and the need to print large quantities of money to support bank runs. This will lead to many banks collapsing in Cameroon, causing extreme disruption to the economy by cutting off credit channels, even for profitable companies.

2) Choosing the right exchange rate regime
I do not get a sense by running inflation models for Cameroon since 1960 that the country has stabilized inflation. I fear that pegging on future exchange rates without this may not alleviate inflation expectations. This may lead to real appreciations and current account deficits that expose them to speculative attack. Much of the financial sector and corporations may suddenly find themselves insolvent.

3) The proper sequence of reform measures
Cameroon’s economy has been going through a series of distortions for quite a while now.  I am a little concerned that ignoring the principle of second best, whereby when an economy suffers from multiple distortions, the removal of a few may make matters worse, not better. Additionally, I do not know that there are proper safeguards and supervision in place for financial institutions in Cameroon to cope with such distortions. At a time when growth is still fragile post 2008, foreign capital which is already at historically low levels, may flee with an economic slowdown leaving domestic banks insolvent. BEAC should insist that Cameroon delay opening their Capital account until it is sure that the country’s financial sector can handle the potential distortions.

Such an unexpected devaluation of the CFA will lower the foreign currency value of the government of Cameroon’s domestic currency liabilities to the private sector. The initial reserve gain by BEAC will be financed by a surprise tax on the holders of government bonds and money.

Reference:
Paul Krugman & Maurice Obstfeld ‘International Economics (2000)’ Theory and Policy
The CFA Franc: new peg for a common currency http://www.un.org/ecosocdev/geninfo/afrec/subjindx/124euro3.htm

Comments

[Akaba Ndiateng]

Mr Njila, I wonder why in your analysis of this "devaluation" rumor of the CFA frs, mention of the first devaluation in the 90's is more like an afterthought. Some more information on its history, how the monetary institutions reacted, how the government handled it, and how it impacted and has defined the lives of Cameroonians would have been instructive acrosss the board (macro and micro economics).

Would you be kind enough to dig into some of these questions in a substantive, yet concise and considerate fashion? Especially, would you consider to address the question of the devastatng consequesces of a bank-run by entities (personal and corporate) in the country? Finally, what else can any proactive government in the CFA frs zone be doing to avert this?

[Mbang]

The question, Mr Akaba, is not what else these moribund, inept and incompetent CFA Frs Zone Ministers and their governments can do. The question, it seems to me, is what will France allow them to do?
Indeed, the question is what can they do? And I honestly think they are already doing what they are best at: wait along for France to tell them what to do.
Afterall, what do these sleeping heads understand in a language that is not theirs, or in a currency they don't print and never initiated. These countries, former French colonies, should not even be called countries. They are what they - French provinces in Africa.

[Meg Foy]

It baffles one to see the quiet and subtle way the citizens of these countries are taking this news. People seem helpless. The wind of change blowing across the Arab world is far from central/west Africa. Right now Europeans are meeting to seek ways to alleviate the damage of the general economic storm on their economies, and the best way for France is to come to its farms in Africa to squeeze whatever it can as usual. My people say if you don't know who you are, you shall be told. What a shame on central west Africans,What a shame for the helplessness.

[limbekid]

@ Meg Foy,

Please don`t get over yourself. The rumour might materialise, but until then it remains a rumour. A Cameroonian citizen has done the responsible thing by bringing it to the limelight and explaining the mechanism (to the best of his ability).

[Marxcell]

This whole writing as the field of economics from which it anchors the assessment is highly speculative. This contribution could well have been written without premising it on the so-called rumors. The rudimentary economic lesson provided in the write-up is welcome to the average reader uninformed in basic micro and macro economics but for the most part the long and winded presentation is unnecessary.

The premise of course, is wrong. It is not true that talks about the imminent devaluation of the CFA has not been challenged or that prominent Franc financial ministers have not spoken out on the matter. They have done so and have at various instances telegraphed their messages to calm fears precisely to those doing business and/or hold long cash positions in Central and West Africa banks. That kind of jog from an economist is really inconsequential since in fact he must speculate. This is worth noting because speculative rumors as well as assumptions are not empirical facts. All what is said relying on such assumption are dubious at best even if they make for a juicy write up.

Here is a fact for you .... Dr. Gary Busch statement quoted in the Nov 22 Daily Telegraph that an agreement to devalue the currency had been reached between Africans Central Banks and the French.....as well as Alassane Ouattara travel plans to the 14 CFA member countries. That being the case all what is important to understand is how they are preparing for the any kind of a landing of what seem almost inevitable..the devaluation of CFA. Why do you need verification for what is a reported direct statement? The FACTS is simple. Either there would be devaluation or not. The culprits are well known France and the CFA member states.

It is no news that the business and gains in currency trading do not rely of perfect information. The answer it seems for any serious currency devaluation is political. What we need then are empirically testable facts that sustain such political explanations.

[DANGO TUMMA]

marcell, dr gary busch have been commenting on African economics/politics, especially their roots caused by the french in their un willing to give africans the true independence to run africas affairs by africans for about 15 years now,
you are very new, and if you are not pro-french as paul bitya or allasane watara, you would see exactly what others see.a country cannot have an economy, unless it have a currency, i meant its own currency.
since the french say the reason the have military bases in africa is to protect their
cronis, france have been stealing africas monies of 85% of gdp for 17 countries since 1948
about 100 trillionm of african monies is in french bank, african have no way to get these money back , they have Ask france to refund it and stopped this cfa, currecncy scammed, but france say now, atleast senegal wade did . instead they look for means to imposed africans with low mentality like watata of cote ivoire or paul biya , bongo, sassou etc, to continue acting as their gate keepers for the france to also come in every month and collect what papa, grand papa mama have worked coffee, coacoa, bayam sellam in the market , and sent to france, thats we africans worked hard instead of saving in our country to better our lives, france will monthly come under the radar and steal 85% wire transfer into its treasury. soo generations by genrations remain poor.

thats part of what ghaddaafi want to stop with the african monetary union. france was the first to go against. we all affect must learn to see the devil for what it is and hate it, if means wagging an open war against france in 2012 as in agiers , soo be it, . france we all know will continue stealing our money , by using some currency named francs. likeit or not

[limbekid]

The BEAC governor on the question of a imminent devaluation:

http://www.journalducameroun.com/article.php?aid=10433

[Desmond]

Who is this so called "Dr Gary Busch" that talks of devaluing CFA,and people care and talk about him.
This guy`s nothing but the western tool/entity conspiring to continue stealing from Africa. Let me ask you"people". What`s the price of a cup of coffee in Paris and a bag of coffee in Douala?
Make the contrast, then you can understand what this stupid Dr`s trying to poison this nation and the empty head leaders are just sitting on their(Buts).

My fear`s most people in this nation do not understand why "devalue". In fact,we are not an industrialize Economy. Thus, the question of devaluation is far of the passe. You don`t d evaluate to sell banana to e.g French supper market or sell uranium for French (Atomic )plants to keep running.

[Marxcell (Prof)]

@Tumma ...what is your point?

@ Limbekid..... Your link should lay to rest the idea that nothing is afoot about the rumors of devaluation....

[limbekid]

Dr Nfor Susungi`s analysis:

http://www.dibussi.com/2011/12/what-is-the-future-of-the-fcfa-zone-in-west-and-central-africa.html#tp

http://www.dibussi.com/2011/12/-what-is-the-future-of-the-fcfa-zone-part-ii.html#tp

http://www.dibussi.com/2011/12/what-is-the-future-of-the-fcfa-zone-part-iii-.html#tp

He and I agree on one thing - despite misgivings about the cfa franc the region is not yet ready for a local currency, but the possibility should be looked into.