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5 Conclusion

The historical record shows that between 1961 and 2012 and over shorter periods since they became politically independent, West African countries have had modest rates of growth of their per capita GDP. They marked a slight improvement in the last few years. Compared to emerging economies such as Brazil, China and India, they have invested and saved modestly and enjoyed limited access to international public lenders and private credit markets. Their limited capacity to borrow internationally can be largely explained by their poor sovereign credit ratings that do not qualify them as investment grade sovereigns. Therefore, their challenge in the short to medium term is to enhance their risk profile and gain access to private international credit market to finance their development efforts. The paper has investigated this possibility and a mechanism through which this could be achieved, namely membership in a common currency union.

The contingent claims approach to assessment and pricing of sovereign debt risk is used to show that if West African countries become members of a common currency union that allows them to use part of the pooled foreign reserves in addition to their own national reserves, they increase the level of assets that can be used to service their sovereign debt thus reducing the probability of default and consequently the riskiness of their debt. A similar effect could also be achieved if the variability of the return on those assets results from the pooling of the reserves. With the help of a numerical simulation, it is shown that the probability of default on the sovereign loan decreases if membership in a common currency union results in an increase in the level of assets or a decrease of their volatility. If the two effects are combined, the debtor country can reach a risk-free status at moderate levels of improvement of the two unlike the case of improvement in one variable only.

The benefits from common currency membership also translate into higher pricing of the sovereign loan and higher proceeds for the borrower country if the arrangement for foreign reserve management gives access to a higher level of assets or causes reduction in the volatility of the assets. The model also shows that membership in the common currency union enhances the capacity of the country to borrow internationally if the level of assets increases, but only moderately because as the level of promised payment on the debt increases as the result of higher debt levels, significantly higher levels of assets are needed to keep the probability of default constant.

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