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Aftermath of the CFA Franc Devaluation

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1995
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SINCE the devaluation of their common currency in early 1994, the member countries of the CFA franc zone have made great strides toward economic recovery. But much remains to be done to consolidate the initial gains in order to achieve sustainable growth with fiscal and external viability over the medium term.

By the early 1990s, it had become clear that the repeated attempts at internal adjustment by the member countries of the CFA franc zone (see box on this page) had not been sufficient to cope with the rapidly worsening economic and financial situations that they faced. (See “Striving for Stability: CFA Franc Realignment,” by Jean A.R. Clement, in Finance & Development, June 1994.) A new strategy had to be found, and the January 1994 devaluation of their common currency was the central element of that new strategy. The devaluation—50 percent in foreign- currency terms for the CFA franc and 33 percent for the Comorian franc (see chart)—was backed up by tight macroeconomic policies and far-reaching structural measures that were designed to improve the countries’ growth prospects and restore confidence in the zone.

The IMF had been active in providing advice to the countries concerned in the period leading up to the devaluation. Once the decision to devalue had been taken, the IMF moved quickly to assist each member country of the zone in formulating a comprehensive adjustment program and in mobilizing the financial resources needed to make the new strategy work (see box on page 25).

The new strategy’s objectives for economic growth, inflation, and the balance of payments in 1994 have been largely met. Progress on the fiscal and structural elements of the new strategy, however, has been uneven, with significant differences between the West African and Central African members of the zone. The main challenge now facing all the countries is to consolidate the progress achieved so far, especially by strengthening the implementation of fiscal and structural policies.

Expected outcome

The new strategy was designed to help zone members regain competitiveness by shifting resources from low-growth sectors, which were often artificially protected, to sectors where countries enjoyed a comparative advantage. The agricultural sector, which employs most of the population, was expected to be the first to benefit, through higher domestic prices for export crops and a shift in domestic consumption toward local products. The same was expected for the nontraditional export and import-substitution sectors. With improved profitability in these sectors, existing capacities would be utilized, growth and employment would be revived, and private investment would be encouraged. This, together with effectively targeted public investment, would lay the basis for further productivity growth over the medium term.

The CFA franc zone comprises the seven member countries of the West African Economic and Monetary Union (WAEMU), namely Benin, Burkina Faso, Côte d’Ivoire, Mali, Niger,

Senegal, and Togo; the six members of the Central African Economic and Monetary Community (CAEMC), namely Cameroon, the Central African Republic, Chad, the Congo, Equatorial Guinea, and Gabon; and the Comoros. On January 12, 1994, the exchange rate of the CFA franc, which had been fixed since 1948, was devalued by 50 percent in foreign- currency terms, and the Comorian franc (CF) was devalued by 33 percent at the same time.

Jean A. P. Clement,

a French national, is Assistant to the Director of the IMF’s African Department.

The new strategy thus aimed to revive output throughout the zone—after falling during 1990–93, real GDP was expected to rise by 1 percent on average in 1994, and by 4 to 6 percent during 1995–96—but cross-country variations were likely to be significant in the short term because of differences in the severity of the initial economic imbalances. These cross-country variations were expected to diminish as a result of increasing economic integration. Consumer price inflation in the zone was expected to rise from 0.5 percent on average during 1990–93 to 31 percent in 1994, and then to drop to less than 7 percent in 1995, and to fall below 5 percent in 1996. The inflation spike in 1994 reflected the projected direct effects of the devaluation on the domestic prices of imported goods, as well as corrections in administered prices and wages implemented in the devaluation’s aftermath. Again, cross-country variations were expected on account of differences in the degree of openness, the terms of trade, and the pace of price reforms. Over the medium term, given the exchange rate anchor, variations in the inflation rates were projected to decline as a result of trade liberalization measures and progress toward regional integration.

Domestic savings were expected to rise from their low level and external and internal imbalances were to be reduced substantially. The ratio of domestic savings to GDP was programmed to increase by about 9 percentage points, and the ratio of investment to GDP by 6 percentage points, during 1994–96. Savings would rise mainly owing to the stronger adjustment in the public sector, which would include repayments of arrears. This effort and capital inflows were expected to provide scope for increased private sector investment.

As the balance of payments improved and external financial assistance flowed in, net international reserves were programmed to strengthen considerably. The larger countries—Cameroon and Côte d’Ivoire, which account for more than 40 percent of the CFA franc zone’s GDP—were expected to have a dominant impact on the overall performance of the zone.

How countries fared

Overall, the objectives for economic growth, inflation, and the external position in 1994 have been largely met (see table). Progress with fiscal and structural policies, however, has been uneven, with particularly significant differences between the member countries of the West African Economic and Monetary Union (WAEMU) and those of the Central African Economic and Monetary Community (CAEMC). In several countries, the problems that have emerged stemmed partly from unsettled political situations. However, all countries generally benefited from a stronger world recovery; better terms of trade resulting from higher commodity prices; and, in several cases, favorable weather conditions.

Inflation. Throughout the CFA franc zone, governments kept firm control over nominal wages in the public sector, and this approach was largely followed by the private sector as well. As a result, inflation was quickly brought under control after the initial surge in prices following the devaluation. As temporary price freezes on a few essential goods and public utilities were lifted, inflation in several countries picked up again somewhat later in 1994, but progress in reducing the underlying inflation rate has continued.

CFA countries Real effective exchange rates and terms of trade,1980–94

(weighted by 1994 GDP, 1985=100)

Sources: IMF, Information Notice System; and World Economic Outlook.

1An upward movement of the real effective rates indicates an appreciation.

2A downward movement of the terms of trade indicates a loss.

The average annual inflation rate in 1994 is estimated at about 33 percent for the zone as a whole (2 percentage points more than targeted); 30 percent for the West African countries (2 percentage points less than targeted); and 38 percent for the Central African countries (5 percentage points more than targeted). Competitiveness improved, as measured by the real effective exchange rate—that is, the inflation-adjusted exchange rate vis-à-vis the zone’s main trading partners. During the first nine months of 1994, the CFA franc depreciated by about 33 percent in real effective terms, broadly as targeted. Wage costs in US dollar terms—another indicator of competitiveness—declined by about 40 percent in the zone.

IMF Supports New Strategy

IMF borrowing arrangements were approved for 11 of the 14 member countries of the CFA franc zone by end-March 1994, and for the remaining 3 by end-September 1994. To put IMF assistance in place as rapidly as possible, programs for a number of countries (Cameroon, the Central African Republic, Chad, the Congo, Gabon, Niger, and Senegal) were first supported by stand-by arrangements, with the expectation that these would be replaced by annual arrangements under the enhanced structural adjustment facility (the ESAF is a low-interest-rate borrowing facility for low-income countries) or the extended Fund facility (the Congo and Gabon), provided the programs continued to be implemented satisfactorily. In other countries where the design of far-reaching reforms was already at an advanced stage (Benin, Burkina Faso, Côte d’Ivoire, Equatorial Guinea, Mali, and Togo), the programs were initially supported by ESAF resources and (for the Comoros) by structural adjustment facility (SAF) resources.

At present, 12 of the 14 countries of the CFA franc zone are eligible to draw under the ESAF. (The Congo and Gabon are not eligible because their per capita incomes exceed the level that defines low-income countries.) Among the five ESAF-eligible countries that had launched their adjustment efforts under IMF stand-by arrangements, only Senegal has begun to implement an ESAF-supported program. During 1994, SDR 357 million ($508 million) was disbursed out of a total commitment to all CFA franc- zone countries of SDR 1.3 billion ($1.9 billion) for 1994–96.

The IMF has also played a critical role in catalyzing financial support for the programs from other sources: about $10 billion of exceptional financial assistance was disbursed in 1994, of which about $7 billion was for debt relief. Shortly after the programs were approved by the IMF’s Executive Board, the countries benefited from rescheduling arrangements with private and bilateral creditors, the latter worked out under the aegis of the Paris Club. The World Bank has collaborated closely in the design of the programs and disbursed about $1 billion of nonproject assistance to CFA franc-zone countries in 1994.

How the CFA franc zone fared in 1993–941
WAEMU 2CAEMC 2CFA Franc Zone
199319941993199419931994
ActualProjectedEstimatedActualProjectedEstimatedActualProjectedEstimated
(annual percentage changes)
National income and prices
Real GDP-1.32.63.1-1.4-1.1-0.4-1.31.11.5
Consumer prices0.631.729.56.233.037.83.131.233.1
External sector
Nominal effective exchange rates 36.3-43.16.7-44.26.5-43.6
Real effective exchange rates 3-2.1-35.2-6.4-32.2-3.9-33.7
Terms of trade-4.1-1.42.11.9-3.20.8-1.4-2.21.5
Exports—volume-4.03.71.64.3-0.4-0.7-0.32.00.6
—value (in CFA francs)-4.4115.2103.62.793.2101.7-1.3106.0102.8
Imports—volume-7.9-0.5-8.90.1-10.0-10.4-4.4-4.5-9.5
—value (in CFA francs)-6.1106.181.9-4.369.470.7-5.390.677.0
Central government finance
Revenue 4-10.549.443.6-15.148.928.5-12.649.236.8
Wage bill1.510.811.6-2.8-7.5-7.8-0.52.42.7
(percent of GDP)
National accounts
Total investment13.117.615.413.418.919.913.218.217.3
Domestic savings8.913.313.016.424.627.612.218.119.3
National savings3.77.88.88.311.116.86.79.212.3
Resource balance-4.2-4.3-2.53.05.77.7-1.0-0.12.0
Central government finance
Revenue 415.816.415.920.417.214.717.816.715.4
Expenditure 525.815.615.630.914.413.628.115.214.7
Balance 5-10.00.80.3-10.52.81.1-10.21.50.7
Sources: Data provided by the respective national authorities and IMF estimates.

Excluding the Comoros

Based on a weighted average using 1994 GDP of the respective countries, where applicable. WAEMU stands for West African Economic and Monetary Union: CAEMC stands for Central African Economic and Monetary Community.

For the period extending from the end of December 1993 to the end of September 1994. (A minus sign indicates a depreciation)

Grants excluded.

Excluding interest payments.

Indicates no data available.

Sources: Data provided by the respective national authorities and IMF estimates.

Excluding the Comoros

Based on a weighted average using 1994 GDP of the respective countries, where applicable. WAEMU stands for West African Economic and Monetary Union: CAEMC stands for Central African Economic and Monetary Community.

For the period extending from the end of December 1993 to the end of September 1994. (A minus sign indicates a depreciation)

Grants excluded.

Excluding interest payments.

Indicates no data available.

Growth. Real GDP for the zone rose on average by 1.5 percent in 1994, marginally above the original target but indicative of a significant turnaround compared with the average annual decline of about 1.0 percent during 1990–93. All but the three largest members of the CAEMC saw positive GDP growth rates. The response of output in the tradable goods sectors to the shift in relative prices has been more rapid than anticipated in most countries, and the structure of consumption has clearly begun to shift in favor of locally produced goods, such as food crops, vegetables, livestock, and, in some cases, light manufactures.

There are also indications that production in the export-oriented agro-industrial and textile sectors has performed well, particularly in enterprises that had been restructured or privatized, and, therefore, were well placed to benefit from the devaluation. Producer incentives have been restored by the considerable increases in producer prices for export crops. Meanwhile, tourism has picked up, notably in Senegal. Trade within the zone seems to have increased rapidly, albeit from a very low base. Most of the other sectors are still undergoing structural changes, searching for new markets, financing, and suppliers. Activity in the nontraded goods sector, especially construction and domestic services, has tended to remain depressed, except in Benin and Côte d’Ivoire.

In the non-agricultural private sector, entrepreneurs have adopted a “wait and see” attitude with regard to private investment, preferring to use slack capacity first. The sluggishness in the private sector may reflect several factors, including the significant contraction in total domestic demand, the slow pace of repayment of governments’ domestic arrears, the low rate of public investment, and the slow implementation of structural reforms. With the contraction in overall domestic demand and the sharp increase in saving, especially in the private sector, the balance between total investment and domestic savings in 1994 is estimated to have been better than expected in all countries except the Congo and Equatorial Guinea.

Financial resources. Many of the countries have benefited from higher-than-projected commodity prices, which have partly compensated for shortfalls in the growth of export volumes. Reflecting these developments and the strong increase in national savings, the foreign reserves of both the Central Bank of West African States (BCEAO) and the Central Bank of Central African States (BEAC) rose sharply ($1.9 billion) during 1994. This also mirrored a much more rapid than projected reconstitution of money balances in CFA francs, financed partly by a repatriation of flight capital. Along with shortfalls in domestic credit, reflecting lower-than- expected demand for credit throughout the zone, there has been a substantial improvement in the liquidity of banks. This has posed a new challenge for monetary policy.

External debt. All countries have reached, or are in the process of reaching, comprehensive agreements with the Paris Club to secure debt relief, largely on concessional terms. The countries have also benefited from substantial debt cancellations from bilateral creditors, in particular France, as well as exceptional assistance from regional and multilateral institutions. The recent agreement of the Paris Club creditors to increase the degree of debt reduction granted to the poorest countries to two thirds of the stock of debt to official creditors should also help in further alleviating the latter’s debt-service burden. Debt to private creditors is important in a few countries. The governments of these countries are negotiating with private banks and other creditors to conclude debt operations on terms that are compatible with their external payments capacity. The total amount of debt relief is estimated at about $7 billion for 1994.

Regional integration. Important progress has been made in enhancing economic and financial integration. With the signing of a new treaty on January 10,1994, and its ratification in June 1994, West African Monetary Union members established the West African Economic and Monetary Union (WAEMU). The WAEMU’s Economic Commission and High Court of Justice were inaugurated in late January 1995 in Ouagadougou, Burkina Faso. Similarly, the Central African Economic and Monetary Community (CAEMC) was established on March 16,1994, and negotiations on conventions that give content to the CAEMC are nearing completion. To avoid unsustainable fiscal deficits and, more generally, excessively high government debt that could jeopardize the functioning of the zone, the two subregions hope to strengthen regional surveillance, particularly with the help of convergence indicators for the fiscal position and external debt. Other initiatives launched recently include plans for developing financial markets, codes for business and insurance activities, and social security, and for the development and monitoring of a regional economic data base.

Fiscal performance and structural reforms. Progress has been slower than originally anticipated in mobilizing government revenue and implementing structural reforms. Total government revenue in the zone, excluding grants, increased by only 37 percent in 1994, compared with the 49 percent originally projected. The difference is largely due to shortfalls in government revenue in the Central African members of the zone (see table). A number of factors have been at the root of the shortfalls. In some cases, these factors—such as strikes, civil unrest, and disruption of trade routes—were outside governments’ control. There have also been larger-than-expected shifts in the structure of consumption and in the composition of imports, including those involved in intrazone trade, toward lower-taxed goods. More generally, however, governments have had difficulty with tax administration, notably customs tax collections, and tax exemptions continue to be widespread.

The slow pace of implementation of structural reforms, partly owing to administrative weaknesses, is the second area where performance has fallen short of expectations in several countries. These shortcomings resulted in the late adoption of revised government budgets, which, in turn, led to delays in implementing public investment programs and in meeting the higher targets for social expenditure.

Future challenges

The main challenges for the CFA franc countries in the period ahead are to consolidate the progress achieved thus far, especially by ensuring that the gains in competitiveness are not eroded, and to strengthen policy implementation in areas where difficulties have been encountered. In the area of government revenue, measures will be needed to enhance performance. As far-reaching changes in the tax structure cannot be achieved in the short term, tax administration has to be made more efficient in order to raise revenue. At the same time, to achieve a revenue structure that is less vulnerable to external shocks and allow a reduction of the tax burden on the modern sectors of the economy, as well as on exports, governments need to implement in a timely fashion measures to broaden the tax base and reduce the scope of exemptions.

The IMF has provided technical assistance in several countries to help implement tax reforms that are already in progress or to identify plans of action in the revenue area. In addition, IMF and World Bank staff are working closely with CFA franc zone governments to help strengthen the implementation of regional customs and tax reforms.

Governments also need to ensure that the targeted outlays for the social safety nets and basic social services are achieved, and that more attention is given to the programming and implementation of public investment. Sound budgetary policy depends on stronger control of public expenditure and avoidance of extrabudgetary spending. At the same time, expenditure policies have to remain flexible and adapt to the evolution of revenues, to avoid any deterioration in the budget balance. The success of the strategy in achieving the desired restructuring and flexibility in public expenditure will also hinge critically on a continued prudent wage policy and on efforts to streamline the civil service.

Another important challenge is to intensify structural reforms. A strengthening of the administrative capacity of the public sector, particularly in tax and treasury administration, should facilitate better management of the limited resources available and the achievement of governments’ objectives in social spending and capital outlays. To respond to this challenge, in collaboration with the World Bank, priorities for action—encompassing comprehensive public expenditure reviews, civil service reform, the design of appropriate public investment programs, the strengthening of the health and education sectors, and public enterprise reform—have been identified in all countries.

The development of a strong private sector capable of becoming the engine of economic recovery and growth is also key to the success of the strategy. This will require simplification of administrative procedures; acceleration of privatization; liberalization of the remaining controls on prices, labor markets, and external and domestic commercial activity; and completion of the restructuring of the financial sector. Also, reform of the instruments of monetary policy, within the framework of the two regional central banks, is essential to promote the development of more liberalized, efficient, and truly regional financial markets. In this regard, decisive steps will have to be taken to develop the regional money and interbank markets, as well as a broad-based market for government securities and long-term instruments for investment financing. A plan of action will have to be defined rapidly to enable the two central banks to move toward a market determination of interest rates, develop the tools of indirect monetary control, and respond effectively to surges in bank liquidity. The pursuit of these structural reforms should be supported by the adoption of an enabling and stable legal framework for economic activity, buttressed in several cases by measures to revamp the judiciary.

The two subregions would benefit from strengthening their efforts to improve regional integration and economic cooperation, so as to avoid inconsistent policies among countries and to facilitate implementation of the common regional elements of tax and budgetary policy, as well as financial sector reform and the expansion of regional markets and trade.

Finally, the current efforts to achieve both macroeconomic adjustment and structural reforms need to be pursued in a sustained and determined manner, to avoid slippages and consolidate the credibility of the bold adjustment efforts that the CFA franc countries have so far undertaken with success.

Jean A.P. Clement

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