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FOREX Africa: The CFA Franc aka The African Euro
As frontier markets, the countries of Africa represent tremendous opportunities and tremendous risks. On the risk side of the ledger are all the usual complications of international trade and investment compounded by the problems inherent in a developing, emergent continental market consisting of 54 countries and 1.1 billion people – it’s a lot to keep track of.
Luckily, the ups and downs of the African currency markets aren’t one of them if you know where to look. To help with that, AFKInsider has compiled all the news you need to know now in order to slim down your currency risk in the week ahead. Let’s see what’s happening out there.
This week we take a look at one of the curious legacies of European colonialism — the CFA franc. Ruined by six years of war and occupation, France created the CFA franc at the end of World World II so it could maintain access to its overseas markets. The CFA franc has weathered nearly 70 years of political and economic change since its inception and has become something of a cornerstone of French-dominated West and Central Africa. The question posed here, though, is to what extent investors looking to put money in the African growth story should consider CFA countries as an investment destination.
What exactly is the CFA franc? It is the legal currency of 14 African countries, 12 of which were at one time part of the French-African colonial empire. Two additional countries, Equatorial Guinea and Guinea-Bissau, also use the CFA franc even though they were not originally French colonies. Their small size and primary trading partners and neighbors all use the CFA franc, making it inconvenient to maintain an independent currency.
Though widely referred to as the CFA franc, the currency as such is in fact two currencies – the West African franc and the Central African franc. They are interchangeable because they are kept at permanent parity with one another. Except for details on the coins and banknotes, they are effectively interchangeable even though, technically, the WAf and the CAf are only legal tender in the countries that officially use them.
Countries Using the CFA Franc
Green = West African franc / Red = Central African franc
Taken together, the CFA franc areas have a combined population of 147.5 million people and economies worth a total $166.6 billion. Thus, the CFA franc is used by approximately 14.2 percent of the continent’s population but, in stark contrast, accounts for only a little more than 5 percent of Africa’s total economic output. This disparity between population and output should give an idea of the degree to which the CFA franc zone is a consistent economic underperformer.
Be that as it may, the benefit to investors of sinking money in CFA franc-denominated assets is that that, by treaty, responsibility for currency stability is placed outside the remit of the countries and governments using it and in the hands of the French treasury. Prior to the introduction of the euro, Paris kept the CFA franc pegged at 100 CFA francs to one French franc. After French entry into the Eurozone in 1999 as one of the Euro’s founding members, the CFA franc became pegged to the new pan-European currency at €1 to 655.957 CFA franc exactly.
For investors, this means that today monetary policy for these countries is effectively set by the European Central Bank. Given that the ECB is the institutional descendant of the famously inflation-averse German Bundesbank, one should therefore expect the CFA franc to be a consistently strong, stable currency that exhibits little in the way of inflation or depreciation. Indeed, that is mostly the case.
One would not know it, however, for all the bad press the Euro has received of late in the financial press. This is because for several years the Eurozone has languished in recession and the future of the euro has repeatedly come into question as a result of the European debt crisis.
Still, despite this, the advantage to investors of the CFA franc’s link to the Euro is clear. Significant downward currency risk, a constant problem for most developing economies, is next to nil. What’s more, as the Eurozone recovers and the European currency regains strength one should expect the CFA franc to appreciate in value accordingly. In 2013 the Euro-pegged CFA franc did exactly that relative to the U.S. dollar. The CFA franc, for all intents and purposes is the euro and the euro, via the French treasury, is the CFA franc.
Unfortunately, this source of strength also brings costs. A strong currency like the CFA franc makes exports from the CFA-franc zone much more costly than they would ordinarily be and as a result economic growth suffers accordingly. Since most of the countries that use the currency are poor, mostly agricultural economies, this has put a stranglehold on their trade and made them overly dependent upon continuing, privileged access to French and, though them, European markets. That this effectively recreates a quasi-colonial trading relationship between France and its former African colonies that benefits France mightily has not been lost on observers.
One way to escape this dependency, of course, is to have a high-value export product like gold, oil, uranium, or cocoa that can sell even with an overvalued currency. Then, as in a country like Gabon – a major oil producer – the benefit of such a strong, overvalued currency becomes clear. Strong commodity exports can easily finance the importation of most everything the country, or, rather, its ruling elites, need. Since domestic markets and banking institutions are simply not developed enough to justify large deposits of export earnings, naturally enough these earnings are deposited back into Western — mostly French and European — banking and financial institutions. These transactions are facilitated, again, by the strong value of the CFA franc.
So, what we have in the CFA franc is a currency area that greatly benefits the ruling cliques that run the countries, but otherwise provides very little in the way of benefit to the average citizen of the CFA franc zone. Sure, the lucky few who benefit from control of the economy may be able to import French wine and Japanese cars at a reasonable price, but the politically excluded – meaning the vast majority – are left behind as the economy does not develop and the society becomes overwhelmingly dependent upon a single, high-value commodity or export market for its economic well being.
This, as might be expected, creates intense political conflict as access to government, not participation in a growing, increasingly diversified economy, becomes the deciding factor in domestic economic outcomes. Indeed, one merely has examine a map of geopolitical conflict in Africa to see that French Africa and the CFA franc zone in particular have and continue to have a troubling, often violent, political history.
To answer the question of whether one should invest in the CFA franc area, one should understand that though currency stability is a huge attraction, this is counteracted by anemic growth and significant political insecurity. In one or two countries the bet may pay off.
Oil-rich Gabon or Equatorial Guinea are attractive prospects – but as for the rest an investor would be advised to stay clear. Growth and political stability just isn’t there in enough quantity or quality to justify the risk regardless of how low the currency risk happens to be.
Jeffrey Cavanaugh holds a Ph.D. in political science with a specialization in international relations from the University of Illinois at Urbana-Champaign. Formerly an assistant professor of political science and public administration at Mississippi State University, he writes on global affairs and international economics for AFKInsider, Mint Press News and BAM South.