FX International Payments
By Frances Coppola
This African currency union was conceptualized long before the Eurozone, and its genesis extends back even further.
In the 19th century, France – like other European countries – acquired colonies in Africa that then adopted its language, currency and many features of its culture. France retained its African colonies well into the 20th century; not until the 1960s did they start to achieve independence. At the time of World War II, therefore, France’s African colonies were using the French franc.
In the aftermath of World War II, the United States and Europe adopted a new currency exchange rate system known as the "Bretton Woods" system, after the place where the agreement was reached. European countries agreed to link their currencies to the US dollar, which itself was convertible to gold. This agreement established the US dollar as the premier reserve currency of the world.
France’s economy was badly damaged in World War II. To help support its recovery, the French franc was substantially devalued before being fixed to the US dollar under the Bretton Woods system. But this would have imposed a large devaluation on France’s African colonies. As part of the Bretton Woods agreement, therefore, a new currency was created for those colonies – the “Colonies Françaises d’Afrique” franc, or CFA franc.
Since the colonies have become independent states, the meaning of “CFA” has changed. Now, it stands for “Communauté Financière Africaine” in West Africa and “Coopération Financière en Afrique Centrale” in the Central African states
The CFA franc is the official currency of two economic communities, the Communauté Economique et Monétaire de l’Afrique Centrale (CEMAC) and the West African Economic and Monetary Union (WAEMU). It is also the official currency of the island nation of Comoros, though there it is known as the Comorian franc.
Currently, CEMAC consists of the following countries: Chad, Cameroon, the Central African Republic, Democratic Republic of the Congo, Equatorial Guinea and Gabon.1 WAEMU comprises Benin, Burkina Faso, Cote d'Ivoire, Guinea-Bissau, Mali, Niger, Senegal and Togo.2 Most of these countries are former French colonies.
CEMAC and WAEMU each have their own version of the CFA franc, together with a central bank to issue it. Currently, the two versions of the currency are not interchangeable, though the two central banks say they are working toward complete integration of payments systems so that the two versions of the CFA franc can circulate freely in all countries, effectively creating one single currency.
Both versions of the CFA franc are hard-pegged to the euro. When the CFA franc was first created, it was pegged to the French franc at 50 CFA francs to 1 French franc. It was devalued in 1994 and then remained at 100 to 1 until France adopted the euro in 1999.3 At that point, the French franc was converted to the euro at 6.55957 to 1. The CFA franc’s currency exchange rate thus became 655.957 to 1 euro, where it remains pegged to this day.4
Although the two versions of the CFA franc are not yet integrated, they are both worth exactly the same in euro terms, and the hard peg to the euro means that their external value is also identical, since their foreign exchange rates float up and down with the euro. So for nearly all intents and purposes, the 14 countries in the CFA franc currency union use the same currency, and that currency can be regarded as a version of the euro.
To ensure that the CFA franc is not forced to devalue through speculative attacks, its convertibility to the euro at the fixed exchange rate is guaranteed by the French government and backed with euro reserves. Since 2010, under the agreement with the French government, 50 percent of those reserves have been held by the French Ministry of Finance.5 Holding the peg to the euro also forces the two CFA franc central banks to follow the monetary policy of the European Central Bank, which effectively sets interest rates for the CFA franc zone.
Some consider the euro peg to be a double-edged sword. On the one hand, it has helped the CFA zone countries to survive recent falls in the price of oil and commodities without currency collapse, inflation spikes and fiscal distress. On the other hand, the strength of the euro may have discouraged exports and encouraged imports, benefiting Eurozone economies – especially France – at the expense of CFA zone countries.6
The origin of the CFA franc in colonial relationships means that trade with France, and more recently with the Eurozone, has tended to dominate in the CFA zone. Trade among member states has been hampered by structural issues, including lack of integration between the two versions of the currency.7 The CFA zone central banks are working toward full integration of payments systems, to facilitate more regional and international trade, and say they expect the two currencies to be interchangeable “soon,” though they have not given a specific date.8
However, in recent years, trade has diversified, with China and the US becoming increasingly important trade partners.9 This has strengthened calls for the CFA franc to be separated from France’s control,10 and even for it to be unpegged from the euro.11 In response to this, France is promoting the creation of a pan-African monetary union similar to the EU, with the CFA zone as its core.12
The CFA zone countries enjoy low inflation, low interest rates relative to those in other parts of Africa, and strong trade links with France. Businesses benefit from the stability of the CFA franc and the credibility of its currency exchange rate peg to the euro. The uncertain future relationship of the CFA franc with the Eurozone may give some observers cause for concern. However, governments in the CFA franc zone are working to improve the area’s economic infrastructure to develop stronger trade links with each other and with trade partners around the world.
With 17 years experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.