What is wrong with monetary unions in Africa?

A recent article published on Burundi Eco provides an update on the progress of the creation of a common currency in the East African Community (EAC). The article notes that despite the efforts made by central banks in this region to harmonize their policies and achieve macroeconomic convergence among their States, this project is becoming increasingly difficult to be achieved. And this situation is not unique to the EAC, as similar attempts in other African regions are facing the same challenges...

The EAC is one of the most ambitious African Regional Economic Communities (RECs), since it is the only one that has adopted an integration roadmap that envisages progress towards a complete political union, passing by the creation of a monetary union. To this end, on 30 November 2013, the EAC Partner States concluded a Protocol for the establishment of the EAC Monetary Union, which initially established a timeframe of 10 years (within 2024) to adopt a common currency. However, in December 2022, an assessment made by a task force appointed by the EAC Secretariat proposed to postpone this deadline, noting that EAC Partner States were still far from meeting the the convergence criteria required for the creation of an EAC single currency. These criteria include the stabilization of the inflation rate at 8%, a ceiling of 3% of GDP on the fiscal deficit, and public debt levels which does not overcome 50% of their GDPs. In addition, EAC Partner States must have stocks of foreign exchange reserves to finance imports over a period of at least 4.5 months.

The conclusions of the task force were confirmed by another assessment conducted by the EAC Secretariat in March 2023, which approved the postponement to 2031 of the establishment of the EAC common currency. But with the accession to the EAC of countries such as Somalia, Burundi and South Sudan - which have inflationary and budget deficit problems that are particularly severe - this process could take longer than expected.

Achieving a monetary union in the EAC - like in other African RECs that pursue this objective - has many advantages, including the reduction of transaction costs, the saving of international reserves, the elimination of exchange risk and the convergence of prices at the regional level. Yet, achieving this more advanced form of integration in Africa has revealed particularly complicated.

To date, the only successful monetary unions in Africa are the Economic and Monetary Community of Central Africa (CEMAC) and the West Africa Economic and Monetary Union (WAEMU, better known by its French acronym UEMOA). These two Communities managed to adopt common currencies which have both been pegged to an extra-continental currency: the French franc initially, and subsequently the euro. Despite the criticism on the colonial legacy of these unions, pegging their regional common currencies to the euro has provided stability and credibility to their monetary systems, making it possible the achievement of stable and working monetary unions.

A similar attempt to establish a monetary union in West Africa has not been so lucky. In 2000, the Economic Community of West African States (ECOWAS) Member States that were not part of UEMOA (with the exception of Cabo Verde), signed an agreement known as the Accra Declaration, which aims at creating another monetary union called the West African Monetary Zone (WAMZ). This second monetary zone was supposed to absorb the Franc CFA by 2020 by unifying both WAEMU and non-WAEMU countries in ECOWAS into a single currency, through the establishment of a common West African Central Bank. However, the timetable for launching the ECO has been postponed several times, also in this case due to difficulties faced by member states in meeting the agreed macroeconomic convergence criteria. Countries participating in the WAMZ have now planned to launch the ECO by 2027, a timeline that some scholars believe will also be missed due to the persisting high inflation rates differentials and exchange rates volatility, which will make particularly challenging the respect of convergence criteria.

Is it possible for a group of States to achieve a monetary union without setting macroeconomic convergence criteria? The answer given by the economic literature to this question is generally negative, because countries that embark in monetary unions without having similar economic fundamentals, such as inflation rates, fiscal deficits, and debt levels, usually experience asymmetric shocks that require different monetary responses, leading to the instability of the single currency, and in the end, to the collapse of the monetary union. Conversely, similar economic conditions in the members of a monetary union foster confidence in the common currency, attracting investment and facilitating trade.

At the moment, the reality in Africa is that the economic performances of States are so disproportionately different, that monetary unions are extremely difficult to achieve. Although there are some historical examples of monetary unions that were formed without first obtaining explicit results in terms of macroeconomic convergence, these unions have been often achieved by linking the new created single currency to a strong external currency, such as in the case of ECOWAS and CEMAC.

But similar experiments would be unacceptable today, in an era in which Africa is trying to develop its own economic and monetary policies, avoiding  any external interference in their determination, which is perfectly understandable. But creating successful monetary unions without first achieving a certain degree of homogeneity in economic conditions among their members is highly unlikely. The benefits of convergence in terms of stability, economic efficiency and risk management outweigh the potential challenges of forming a union without these safeguards.

Pending the achievement of such homogeneity, it could be more realistic to develop forms of monetary coordination between African states, based on a regime of pegging their respective currencies to that of a regional hegemon, i.e., a reference economy whose national currency is more strong and stable than others in the region. This is what SACU members have done, as their currencies have been pegged to the South African rand by transferring responsibility for formulating and implementing monetary policy in the region to this nation, even if today the rand is less stable than in the past, becoming particularly volatile.

Can this model also work in other regions of Africa, awaiting for their states to achieve the long-awaited conditions of macroeconomic convergence that are the necessary prerequisite to develop monetary unions? Giving an answer to this question is not simple, but given the difficulties encountered by African nations in creating monetary unions so far, and in the light of the current unpredictability in the growth of inflation and their national debts, this would certainly an attempt that deserves to be done.