Meet the new boss same as the old boss as the CFA Franc becomes the Eco

As Christmas approaches things usually quieten down but if turn out eyes to Africa and in particular West Africa there have been some currency developments over the weekend. So without further ado let me hand you over to Reuters.

West Africa’s monetary union has agreed with France to rename its CFA franc the Eco and cut some of the financial links with Paris that have underpinned the region’s common currency since its creation soon World War Two.

So we have both an economic/financial element and a colonial one. We have looked at the CFA Franc briefly before but now courtesy of LSE Blogs let us have a refresher.

Firstly, a fixed rate of exchange with the euro (and previously the French franc) set at 1 euro = 655.957 CFA francs. Secondly, a French guarantee of the unlimited convertibility of CFA francs into euros. Thirdly, a centralisation of foreign exchange reserves. Since 2005, the two central banks – the Central Bank of West African States (BCEAO) and the Bank of Central African States (BEAC) – have been required to deposit 50 per cent of their foreign exchange reserves in a special French Treasury ‘operating account’. Immediately following independence, this figure stood at 100 per cent (and from 1973 to 2005, at 65 per cent)……The final pillar of the CFA franc, is the principle of free capital transfer within the franc zone.

As you can see via their relationship with France the countries here became implicit members of the Euro, and follow the broad sweep of its monetary policy. If we return to Reuters the scope of the issue and ch-ch-changes is explained.

The CFA is used in 14 African countries with a combined population of about 150 million and $235 billion of gross domestic product.

However, the changes will only affect the West African form of the currency used by Benin, Burkina Faso, Guinea Bissau, Ivory Coast, Mali, Niger, Senegal and Togo – all former French colonies except Guinea Bissau.

The Central Bank of West African States or BCEAO

If we look at monetary policy here we do see one advantage of this.

The minimum interest rate for bidding on open market transactions (calls for bidding) and the interest rate applicable on the marginal lending window (repo rate), whose levels are currently set by the Monetary Policy Committee at respectively 2.50% and 4.50%, are the principal leading interest rates of the BCEAO.

That is considerably lower than what is common in that part of Africa as Ghana is at 16% and Nigeria 13,5% so there is a gain here.

The Economy

According to Friday’s meeting of the council of ministers for the BCEAO things are in fact going really rather well.

The Council of Ministers has analyzed the recent economic and monetary situation in the Union. To this end, he noted the increased dynamism of economic activity in the third quarter of 2019 as well as the favorable economic outlook in the WAEMU countries. Indeed, growth in real gross domestic product (GDP) came out at 6.6% year-on-year, after 6.4% the previous quarter, under the effect of renewed dynamism in the tertiary and secondary sectors. Economic growth in the Union would be, in real terms, at 6.6% in 2019 as in 2020.

After a year of reporting slowing economic growth that is a cheerful and refreshing report. Indeed whilst more than a few would be screaming DEFLATION looking at the numbers below I welcome them.

The Council also noted the decline in the general level of consumer prices, with an inflation rate, year-on-year, of -1.0% in the third quarter of 2019, after -0.7% in the previous quarter, in combination with falling food prices, favored by abundant cereal production.

Firstly in spite of the fast rate if economic growth these are countries with plenty of poor people who will not only welcome lower food prices they may be a matter of life and death. Also low and indeed negative inflation can be combined with a good economic run and not need the economics establishment to rev up REM on their turntables.

It’s the end of the world as we know it
It’s the end of the world as we know it

Although there is a catch if the price falls are for products produced and exported.

Thus, price reductions were recorded for cashew nuts
(-23.5%), palm kernel oil (-17.2%), robusta coffee (-7.1%) and cotton (-4.2%). On the other hand,
increases were noted for petroleum (+ 8.8%), rubber (+ 6.5%) and cocoa
(+ 5.0%).  ( BCEAO 2nd Quarter)

There is however a de facto consequence of implicit Euro area membership.

To this end, they invited the member states to continue efforts aimed at bringing the budget deficit below the Community standard of 3.0% of GDP, in particular by widening the tax base and improving performance. as well as the efficiency of tax administrations.

In case you are wondering about the other component of the Stability and Growth Pact it doesn’t really apply at the moment.

Preliminary data point to an increase in total debt to
52.5 percent of GDP in 2018 from 50.1 percent in 2017. ( IMF)

However bond yields are much higher so there are debt servicing issues.

and in total debt service to 33 percent of
government revenue in 2018 from 26.4 percent in 2017. ( IMF)

 

Also the burden is rising.

It rose by 17½ percentage points of GDP over
the last 5 years to reach 52½ percent
at end-2018. ( IMF )

Trade Is A Problem

The IMF puts it like this.

The external current account deficit is estimated to have increased to 6.8 percent in 2018 from 6.6 percent of GDP in 2017. This increase was underpinned by strong public capital spending but also by worsening terms-of-trade
on the back of higher world oil prices.

This is an issue and points straight at the currency being too high which is a challenge for the CFA Franc because it is a fixed exchange rate.

Ch-Ch-Changes

Back to Reuters.

Under the deal, the Eco will remain pegged to the euro but the African countries in the bloc won’t have to keep 50% of their reserves in the French Treasury and there will no longer be a French representative on the currency union’s board.

Comment

In economic terms this is a case of meet the new boss same as the old boss. The switches above are more symbolic than real economic changes as the broad reality is that the Eco is pegged to the Euro. As we stand that is not going too badly with economic growth having been strong for some time.

Despite adverse terms-of-trade shocks and security concerns in some member-countries, real GDP growth is estimated to have exceeded 6 percent for the 7th consecutive year in 2018, fueled by strong domestic demand. ( IMF)

Inflation is also low,

But whilst it is an establishment fashion to look at the fiscal deficit and of course that is a Euro area obsession and some might argue fetish the real issue for me is elsewhere. It is the trade position where we see that whether you call the currency the CFA Franc or the Eco it is too high and as inflation is low maybe a devaluation is in order. Where have we heard that before concerning the Euro?

Podcast

 

 

 

Where next for the economy of Saudi Arabia?

A clear economic feature of the last year or so has been the spectacular fall in the price of crude oil. In spite of the recent bounce the price of a barrel of Brent Crude Oil has fallen by some 51% over the past year to US $49 per barrel. This represents quite a transfer of income and wealth from the producing nations to the consuming ones. I noted an estimate on CNBC a week or so ago of between US $900 billion and US $1.3 trillion which seems on the high side to me. Today I wish to look at the impact on the nation which in oil terms at least is most associated with its price and outlook and that is Saudi Arabia.

The Budget is tightening

In many ways being Saudi Finance Minister must have seemed one of the easiest jobs in the world! After all the price of the country’s main resource crude oil remained with one brief exception over US $100 per barrel from early 2011 to the latter part of 2014. Thus the revenue gushed in. The Persian Gulf Fund put it thus a few years back.

Saudi Arabia has the biggest oil reserves in the world and it is the second largest oil producer after Russia. Oil production gives 40% of the country’s GDP and as much as 80-90% of its budget revenue, which means that Saudi Arabia’s ability to spend money is quite directly associated with oil prices.

According to the International Energy Agency Saudi Arabia produced 13.1% of the world’s oil based hydrocarbon supply in 2013 and was by far the largest exporter in 2012 with some 371 million tonnes or 18.7% of the world total. Of course between then and now has come the shale gas and oil revolution especially in the United States but for quite some time the oil based revenue situation for Saudi Arabia could hardly have been more favourable.

This morning however on CNBC the Saudi Finance Minister Ibrahim al-Assaf said this.

We have built reserves, cut public debt to near-zero levels and we are now working on cutting unnecessary expenses while focusing on main development projects and on building human resources in the kingdom.

He was deliberately vague about what expenses are now considered unnecessary but there is a clear change of emphasis and tenet. Also those who follow the Jim Hacker line of “never believe anything until it is officially denied” will find the next bit to be ominous. From the BBC.

Talking to broadcaster CNBC Arabia, he said the country was in a good position to manage low oil prices.

What about the reserves?

Saudi Arabia built up a strong position in terms of foreign exchange reserves which peaked at just under 2.8 trillion Riyals in August 2014. However the figures for July of this year (the latest) show that they have declined to 2.51 trillion Riyals. So plenty left but a hint that not even Saudi Arabia can carry on regardless for ever with a lower oil price.

A pegged exchange rate

Linked into the situation with the reserves is the level of the Saudi Riyal exchange rate which was pegged to the US Dollar at an exchange rate of 3.75 to 1 back in 2003. Here we see one of the weaknesses of a pegged exchange rate as the strong US Dollar has taken the Riyal with it just when it would have fallen and probably considerably in response to the fall in the oil price. An example of this has been the Russian Rouble where it now takes 68 of them to buy one US Dollar as opposed to the 37 of a year ago. Now there are all sorts of consequences from a plummet in your exchange-rate of that size with inflation being the most obvious but the only exchange-rate flexibility Saudi Arabia currently has depends on what happens to the US Dollar via the US economy. I guess they too are wondering what the Federal Reserve will do next week!

There has been speculation that the peg will be abandoned and several times this year it has come under pressure. But as you can see from the size of the reserves about Saudi Arabia can hold it for quite some time if it wishes.

Saudi Arabia has tended to overspend

As the money has flowed in then Saudi Arabia has not really needed to maintain much of a grip on public expenditure. The US-Saudi Arabian Business Council tells us this about last year.

Expenditures, originally estimated at $228 billion (SR855 billion), stood at $293.3 billion (SR1.1 trillion).  This increase is 28 percent above the budgeted level but not significantly higher than the average amount of overspending recorded over the last ten years.  This resulted in a budget deficit of $14.4 billion (SR54 billion) in 2014.

Food for thought there as we note that in what were much more favourable times there was a deficit albeit a small one. This was in spite of the fact that revenues were yet again gushing in.

While the 2014 budget originally envisaged revenues of $228 billion (SR855 billion), they actually amounted to $278.9 billion (SR1.046 trillion).

Many countries including my own would love that revenue situation! But of course the picture for 2015 looks very different if the year to September is any guide to the rest of it.

Saudi Arabia has set a state budget for 2015 with total revenues projected to reach $190.7 billion (SR715 billion) and total spending valued at $229.3 billion (SR860 billion) which is expected to result in a $38.6 billion (SR145 billion) deficit.

If we look at the way that the country overspent last year then one immediately wonders how much of an overspend there will be this and thereby how large the deficit will turn out to be. Last month the IMF pitched in with its estimate on the situation.

A central government fiscal deficit of 19.5 percent of GDP is projected in 2015, and while the deficit will decline in 2016 and beyond as one-off spending ends and large investment projects are completed, it will remain high over the medium-term.

As ever with the IMF it is about to get better! The real question if we look at the obvious political issues in the region is whether Saudi Arabia will feel under pressure to spend even more.

What about issuing bonds?

You can imagine that this has not been a Saudi priority for some time. But as Bob Dylan put it.

Then you better start swimmin’
Or you’ll sink like a stone
For the times they are a-changin’.

More prosaically Trade Arabia puts it like this.

Moreover, for the first time in eight years, the government is also expected to issue local bonds worth SR115 billion ($30.7 billion) through the second half of 2015 to cover around a third of the deficit.

This is underway as just over US $5 billion of bonds were issued a month ago. It is also true that there is plenty of scope to issue them as the IMF points out.

Nevertheless, government debt is very low and was 1.6 percent of GDP at end-2014.

Comment

So there are fiscal troubles in Saudi Arabia leaving it with a choice. One is to continue with its spending plans and support GDP growth in a manner similar to Keynesianism. The other is to take the IMF style approach and to cut back in a more austere manner. In some ways the IMF has a cheek as whilst exports have fallen Saudi Arabia has had many years of balance of payments surpluses.

As to the underlying economy it grew by 3.5% last year and have just seen this on the money supply.

Broad money supply (M3) rose by an annualized 10.5 per cent in June, indicating continued expansion of economic activity, said a report in Arab News, which cited NCB’s Saudi Economic Review for August 2015.

However this is also true.

the pace of annual growth has been in deceleration since the beginning of the year,

Thus there is something of a squeeze going on and I am reminded of the lyrics of the Clash.

The oil down the desert way
Has been shakin’ to the top
The Sheik he drove his Cadillac
He went a-cruisin’ down the ville