PAPSS for dummies

The Pan-African Payment and Settlement System (PAPSS) is a centralized payment, clearing and settlement system for intra-African trade payments jointly developed by the AfCFTA Secretariat and Afreximbank which has been rolled out end of September 2021. It aims at streamlining and securing money flows across African borders by simplifying transactions made by using one of the 42 local currencies that are currently adopted in the continent. The system allows traders to complete these transactions in almost real-time (in less than two minutes) for a low fee. A recently published article explains in simple terms why this system has been developed and what are the advantages for African traders, along with its challenges. We will try to further simplify its content to explain the main reasons that are at the basis of the functioning of the PAPSS.

First, we must clarify that the idea to create an interbank settlement system that facilitates real-time cross-border funds transfer by allowing the processing and settlement of transactions in local currencies is not new in Africa. It lays its foundations on similar systems developed at sub-regional level by some African Regional Economic Communities (RECs) about 10 years ago. These RECs are: the East African Community (East African Payment System, EAPS), COMESA (Regional Payment and Settlement System, REPSS) and SADC (SADC Integrated Regional Electronic Settlement System, SIRESS). However, such systems have been so far embraced only by a small member States of such Communities, except in SADC, where its application is particularly widespread.

The EAC launched the EAPS in 2014. This system operates on a real-time basis by utilizing the linkage between the various Partner States’ Real Time Gross Settlement (RTGS) systems via the SWIFT (Society for Worldwide Interbank Financial Telecommunication) messaging network for safe and secure delivery of payments and settlement messages. At the time when the EAPS was operationalized, only three EAC Partner States (Kenya, Tanzania and Uganda) had implemented a national RTGS system. These countries initiated cross-border fund transfers in their national currencies by using the existing RTGS infrastructure for making cross-border payments. Rwanda joined the EAPS in December 2015 after completing the implementation of its RTGS in 2014. Burundi, which recently completed the implementation of its RTGS, is expected to join it soon. Same for South Sudan, which is expected to join EAPS as soon as will implements an RTGS system, to date not yet occured.

The COMESA REPSS works in a similar way to the EAPS and aims at eliminating the costs of converting local currencies into hard currencies (euros and dollars) in funds transfer for cross-border payments in the region. Launched in 2016, like the EAPS, the REPSS uses the SWIFT network for safe and secure delivery of payments and settlement messages. At the moment, it is operational only in 9 COMESA countries.

Lastly, SADC adopted an Integrated Regional Electronic Settlement System (SIRESS) as a regional payment and settlement system to facilitate funds transfer for cross-border payment in the SADC region. Subsequently renamed SADC-RTGS, the system first went live in July 2014. To date, all the SADC members participate to it, but not all of them regularly use this platform to settle transactions. The latest statistics available (January 2023) show for instance that Madagascar has only one bank participatring to the system and that in the last 6 months of 2022 there were no transactions settled under the SADC-RTGS. The SIRESS/SADC-RTGS system is reported to have reduced the intra-SADC transaction time from approximately two to three days, to just 24 hours.

Let’s see then the reasons why a settlement system is much needed in Africa. The article we comment in this post explains these reasons clearly. It first explains that African countries are highly exposed to fluctuations in international currency markets due to their dependence on trade with stronger economies (ex. China, United States or the European Union). As most of them are import-dependent economies, and they import a lot from these external trade partners, they need to buy on international markets huge quantities of dollars or euros to pay their suppliers in these economies. The reliance on such foreign currencies for trade settlement gives rise to additional costs for traders, that have to convert their local currencies in these hard currencies in order to pay their extra-continental suppliers.

The question is why then African traders cannot pay at least their suppliers in Africa with their own currencies? The article explains that most African currencies cannot be directly converted with each other, as they are not accepted by their banking systems. Let’s make an example. We can imagine a transaction made between a buyer and a seller established in two different African countries, let’s call them A and B. In most cases, these traders will not be able to exchange their respective currencies with each other because their banks will refuse to convert them into the local ones. This happens because if they accept these currencies as a direct means of payment, they will incur into the risk of accumulating them in excess in their coffers, remaining unused if no one will require them to make other payments to the country that issued that currency, due to imports from that country.

Let’s suppose for instance that an importer from Kenya wants to buy products from Nigeria. His Kenyan shillings will not be accepted by the Nigerian exporter, because his bank will not risk to accumulate reserves of Kenyan shillings in its coffers, considering that the demand of Kenyan shilling is low, as Nigeria imports very little from Kenya. Accordingly, the Kenyan importer will be obliged first to convert his shillings in another stronger currency (by buying US$ or euros from his bank), and then transfer the relevant amount to the bank of the exporter in Nigeria, which in turn will re-convert the dollars or euros into Naira and transfer the relevant amount to the exporter. Apart from the cost of these operations (as the banks apply to the traders a fee for each conversion), in many cases it happens that the bank of the importer has no sufficient reserves of US$ or euros. This will cause to the importer long waiting periods between the time the order is placed and goods are delivered. This problem is frequent in Africa, as documented in this recent article.

The PAPSS system basically avoid these multiple conversions, as a clearing house-settlement agent (Afreximbank, in partnership with African Central banks participating to the system) ensures the conversion from one African currency to another without the need to first convert them in dollars or euros. The system avoids therefore economic operators to pay bank conversion and transaction fees that AfreximBank has estimated to be of about 5 billion USD per year. The article, however, also points out two major challenges that exist and that can compromise the functioning of the PAPSS:

Trade imbalances: Trade volumes between African countries are in most cases uneven. For example, often the country A exports a lot to country B, while the country B exports little to A.

Exchange rate risk: As trade rarely occurs instantaneously, there's a risk of currency fluctuations between the time an order is placed and the product is delivered.

The PAPSS success will ultimately depend on the solution to these two challenges, and on the continent's ability to reduce reliance on external trade, increasing the volume of trade exchanges between African countries, what is generally called intra-African trade.