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Part I Analysis of West Africa's Economic Growth

Impact of Common Currency Membership on West African Countries' Enhanced Economic Growth

Diery Seck

Abstract In spite of their current high growth episode, the level of financing of West African economies is too low to ensure sustainable long term economic growth. Their domestic savings are insufficient and their access to foreign borrowing from official creditors is also low. For most countries foreign indebtedness from private creditors is non-existent because of their poor credit risk ratings. Given their inability to improve their sovereign risk profile in the short to medium term, participation in a broad common currency union (CCU) can be the only means to achieve significant reduction in sovereign credit risk and borrow from international private creditors, the largest source of global finance.

With the theoretical model of Contingent Claims Analysis (CCA), it is shown that West African countries can combine their foreign reserves and, through a facility of mutual insurance against adverse debt service outcomes, increase the expected level of net foreign assets available for external debt service, and possibly lower its volatility. The simulation model of the CCA shows that, as members of a CCU, West African economies can benefit from a lower credit risk score that translates into easier access to private creditor lending than in the absence of CCU membership. Once a suitable level of risk is attained, borrower countries can raise their level of indebtedness without changing their risk profile provided the level of foreign reserves available to service their debt increases commensurately.

Keywords Regional integration • Common currency union • Africa\'s economic development • Africa\'s external debt • Contingent claims analysis

JEL Classification O110: Macroeconomic Analyses of Economic Development

1 Introduction

Over the last few years, the West African sub-region has experienced an episode of high economic growth that seems likely to continue in the near future. While its performance has been rather satisfactory, it did not equal the achievements recorded by leading emerging economies such as China and India during their high growth periods[1]. Furthermore, in spite of relative consistency in the economic outcome of the recent past, it is not certain how long this upturn will be sustained or what could fuel it in the long run. It can be argued that, in the current absence of significant increases in productivity and international competitiveness, West Africa's economic growth is largely fueled by price increases in export commodities and favorable global demand, two factors that are prone to variability and beyond the control of developing countries in general, and West Africa in particular. Then, how to secure long term economic growth of West African countries in the context of their low level of development, relative marginalization from world markets and severely limiting poor capacity to finance their economies?

After years of attempts at economic development at the national level without much success, West African countries have undertaken a strategy of regional integration, the key feature of which is establishment of a common currency that aims to include all 15 countries of the sub-region, members of the Economic Community of West African States (ECOWAS). Can a common currency union contribute to economic growth of its members? Frankel (2004) cites the benefits of a fixed exchange rate regime, which characterizes a common currency arrangement, as follows. The fixed exchange rate regimes (i) provides a nominal anchor for monetary policy and represents a credible commitment to fight inflation; (ii) promotes trade and investment by reducing speculative bubbles; (iii) prevents competitive devaluation and (iv) avoids speculative bubbles in exchange rates[2]. Lee and Barro (2011) add that a developing country stands to gain from a fixed exchange rate regime through membership in a common currency union with increased access to long term international financing because it would be able to borrow on better terms due to lower prospects of devaluation and lower expected domestic inflation. The current paper argues that better access to foreign long term financing can also be achieved thanks to a common currency union through a specific arrangement on foreign reserve management.

The purpose of the study is to show that in spite of their current high growth episode, West African countries have a record of historically low growth performance characterized by low investment, low savings rates and very modest access to international sources of credit caused by their poor credit ratings. But, this situation can be improved if they become members of a common currency union that gives them access to additional foreign reserves and enhances their capacity to service their sovereign debt obligations.

The paper is organized as follows. In the next section, the current situation of West African countries is portrayed through the triple lens of their poor record of economic growth over the last half century and over any shorter sub-period except for the last few years, their limited capacity to finance their economies with domestic savings or international borrowing, and their inability to access international debt markets because of their disqualifying low credit ratings.

  • [1] According to IMF's Regional Economic Outlook for Sub-Saharan Africa, April 2014, Table AS1, the Economic Community of West African States (ECOWAS) recorded real GDP growth rates of 6.8 %, 6.8 % and 6.1 % for 2011, 2012 and 2013 respectively. Its growth rate is expected to reach 6.7 % or both 2014 and 2015. By comparison, according to the World Bank's World Development Indicators, the annual growth rate of China's GDP was 10 % in 2003 and 2004, 11.3 % in 2005, 12.7 % in 2006 and 14.2 % in 2007. Over the same period, India recorded 7.9 % in 2003 and 2004, 9.3 % in 2005 and 2006 and 9.8 % in 2007.
  • [2] Lee and Barro (2011, p. 13).
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