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ISSN: 22782278-3369 International Journal of Advances in Management and Economics Available online at www.managementjournal.info RESEARCH ARTICLE The Impact of the Devaluation of the CFA Franc on the Trade Balance of EMCCA Countries Sibe Jacob Pegou, Nembot Ndeffo Luc, Tafah Edokat E Faculty of Economics and Management-University of Dschang. *Corresponding author:[email protected] [email protected] Abstract The study evaluates the impact of the devaluation of the CFA1 franc on the trade balance of EMCCA2 countries. We have put emphasis on We have put emphasis on a panel data regression model analysis to estimate our parameters. The analysis of the data is carried out from 1980 to 2006 and the sources of our data are World Bank secondary data collected from world development indicators and World Bank Africa database CD ROMS. We reach the conclusion that the devaluation of the CFA Franc had a positive impact on the trade balance account of the EMCCA countries, whereas this impact was not sufficient to bring about a meaningful transformation in the competitive advantage position of the EMCCA countries. Thus we propose some policy measures to be undertaken by the EMCCA monetary authorities such as; the amelioration of intraregional exchanges which will result to a consistent reduction of imports, and as a result and increase in exports. Moreover, EMCCA countries should envisage the creation of their own currency with a flexible exchange rate which will enable all the member countries to have control over their monetary policies, thereby giving these economies some level of economic independence. Keywords: CFA Franc, Devaluation, EMCCA, Trade balance, Jel classification: E42, F32. Introduction Currency devaluation is a stabilisation policy measure which some countries undertake to ameliorate the competitive advantage situation of the economy, by reducing imports and fostering exports of goods and services with the aim to impact positively on the balance of payment, and also to recoup with economic growth. During the 1980s, most African countries and particularly those of the EMCCA region were suffering from an unprecedented economic crisis. This was characterised by the heavy debt burden of EMCCA countries, associated with negative macroeconomic indicator indices, blowing an alarm that the situation was critical in the EMCCA region1.The Gross National Product (GNP) of EMCCA countries, reduced globally by 4.53%. It was as a result of the poor economic performance of all the member states of the CFA Franc zone in general, and the EMCCA zone in particular that the issues of the over-evaluation of the CFA currency became alarming. The drastic fall of the macroeconomic indicators of these countries along with structural disequilibrium in the balance of payment of all the member countries in the CFA zone pushed these countries to jointly agree with France to devalue the CFA Franc; that was on the 11 of January 1994.The main objective for the devaluation of the CFA 1 2 African Financial Community. Economic and Monetary Community of Central Africa. Nembot Ndeffo Luc et. al.| July.-Aug. 2012 | Vol.1 | Issue 4|157-164 Franc currency were to restore the competitive advantage of the EMCCA member countries, through the amelioration of the trade balance position of the EMCCA countries (increase of exports associated with reduction of imports), and also a reduction in the budgetary disequilibrium in all the member countries [1].In this study, our main question is to know whether or not, the devaluation of the CFA Franc enabled the member countries of the EMCCA zone to reach their objective. In other words, did the devaluation of the CFA Franc contribute to restore imbalances in the balance of trade of the EMCCA countries’ economies? To be able to answer this question effectively we carried out the study from 1980 to 2006, and we divided it into two sub periods (1980-1993 the pre-devaluation period) and (1994-2006 the post-devaluation period). The panel data regression analysis used throughout this research is inspired from the work of Thiry F. [2].The whole article is scheduled as follows: literature review, results and discussion, conclusion, recommendation and references. Literature Review To be able to have a good understanding of this paper, we must make a review of related works undertaking by various scholars. 157 Available online at www.managementjournal.info Theoretical Review Many writers have carried out research on related topics, where interest was focus on the relationship between monetary adjustment and competitiveness of the economy. The absorption model of Alexander S. [3] for instance supposes that the current account balance of a nation is determined by the difference between real revenue and absorption. He went further by stating that devaluation impacts at two levels: First on GDP and secondly through the revenue effect on expenditure. In Alexander’s model the movement of capital is not taken into consideration, as much as the reduction of the absorption effect does not guarantee the amelioration of the balance of trade deficit. Mundell and Fleming [4] came out with some improvement to Alexander’s model by introducing the money market in their analysis. Mundell and Elasticity Approach or the MarshallMarshall-Lerner Condition The elasticity approach, which is called “imperfect substitute” model, has always been the commonly used method in the analysis of trade balance [5]. On this problem, the key is to test the influence of the trade flow on the relative price, or rather, whether the depreciation of currency will improve the trade balance [6]. In other words, whether the Marshall-Lerner Condition holds? The condition seeks to answer the following question: when does a real devaluation (in fixed exchange rates) or a real depreciation (in floating exchange rates) of the currency improve the current-account balance of a country? [7]. The assumption of MarshallLerner Condition are as follows: firstly, with other condition unchanged, we take the influence of exchange rate changes on the traded goods; secondly, without considering the capital flow, international balance is equal to the trade balance; thirdly, the supply of traded goods are of full elasticity; fourthly, the trade balance is balanced. Resting on the above assumption, we assume that and denote the elasticity of export and import respectively and then we achieve the following conclusion: a. If , the devaluation of home currency will improve the trade balance; b. If the devaluation of home currency will make no difference to the trade balance; c. If , the devaluation of home currency will deteriorate the trade balance. LausenLausen-Metzler effect or “J” Curve effect Devaluation has two counteracting effects: the price and the volume effect. The price effect contributes to the worsening of current account Nembot Ndeffo Luc et. al.| July.-Aug. 2012 | Vol.1 | Issue 4|157- 164 Fleming emphasise on the fact that the market of goods and services is always simultaneously in equilibrium with the money market. Their model emphases on the simultaneous equilibrium in the money market and the market of goods and services, enabling them to analyse under different exchange rate regimes the impact of alternative macroeconomic policies on the production possibility curve of a country after a change in monetary policy. Mundell and Fleming also insisted on the free movement of capital in the economy and on the fact that the economy is open, but never did they mention in their analysis that the effects of devaluation also depend on the nature of the elasticity of supply and demand of goods and services produced by an economy. The Marshall-Lerner condition and the J-curve of devaluation enable us to fell this gap. balance because the devaluation makes export cheaper and import expensive, while the volume effect contributes to improve the current account balance, because cheaper export should lead to an increase in the volume of exports, while more expensive import should lead to the decline in the volume of imports. The J curve explains this phenomenon taking into consideration the time factor in the manifestation of these effects. The price effect is quasi immediate after a devaluation, whereas the volume effect takes time to manifest itself; depending upon the production capacity of the economy to react, by implementing new measures to boost production and thereby increase export, knowing that domestic goods become relatively cheaper in the international market, while foreign goods become relatively expensive. The manifestation of this effect is then known as the volume effect, where the volume of exports increases while the volume of imports reduces. Thus when we observe that the current account balance of a country declines subsequent to the devaluation of its currency, and a few months after the country’s current account balance start to increase, we conclude that we are in the presence of a J-curve effect [8]. Therefore a real devaluation in the beginning results to a decline in the balance of trade in the short run, then after some few months when the economy starts to adjust itself, the positive impact of the volume effect start to manifest itself. But it should be noted that this mainly depends on the elasticity of demand of export goods and services in the country in question.. Thus the sustainable adjustment in the competitive nature of a country depends on the ability of that country to absorb and control inflation that will occur on the prices of imported goods as a result of devaluation in the short run; and in the long run the country should 158 Available online at www.managementjournal.info be able to boost production in other to generate a positive balance of trade. Empirical Review The impact of devaluation on the balance of trade has been questioned by many writers years ago, from the work of Ricardo Bebczuk et. al. [9], it was demonstrated that from the traditional point of view, a real devaluation improves the trade balance. This was acknowledged by the fact that their results led to the conclusion that exportable producers were better off after the devaluation. Not only does the supply of exports increase but also a depressed aggregate demand of imports for consumption and investment purposes ensues. The authors went forward to show how this satisfies with conditions in the sense that, as long as, the conditions are satisfied, a real devaluation will have a positive effect on the trade balance. In this writings the authors Ricardo Bebczuk et. al. [9] showed that the Mundell et.al. [4] model adopted this approach, implying that devaluations are expansionary. This was shown in their assay where the model developed by the authors permitted them to conclude that the beneficial revenue effect for tradable producing industries outweighs the detrimental one for nontradable producers and the negative impact on the tradable sector that arises from the more expensive imported inputs. They also showed that an income effect adds to the previous substitution effect: as far as nominal wages do not fully adjust to the new price level, household disposable income was negatively affected, with a deleterious impact on aggregate consumption coming from the inflation in the tradable consumption basket. To add spices to this point of view, some policies makers and monetary government authorities believe that this policy measure as propounded by Meade, Takayama, Tsiang [10-12] is welcomed to resolve the problem of trade balance deficit. These authors show that the devaluation of a currency improves the balance of trade of the country as well as the production capacity of the said country, when the Marshall-Lerner condition is satisfied. Such conclusions arouse the attention of some researcher like Chen and Krugman et. al. [13,14], and also who explained this empirical phenomenon using theoretical models. Empirical studies carried by many other researchers like Edwards [15] and recently Bahmani-Oskooee [16, 17] also concluded that devaluation results in the improvement of the balance of trade of a nation. During the past years many other models have been put in place to have better answers on the impact of devaluation on the trade balance; among these models we can count that of Hsing [18] who used the IS-MP-AS model to evaluate the impact of devaluation, that of Obstfeld et. al. Nembot Ndeffo Luc et. al.| July.-Aug. 2012 | Vol.1 | Issue 4|157- 164 [19], Betts and Devereux [20-21] and also Devereux who used the general inter-temporal equilibrium model to address the same question. But up to date even though some researcher like Didier [22], [3] Coste [23] have addressed the issue of the devaluation of the CFA Franc in the CFA zone globally, none apart from Fiodenji [24] to our knowledge has addressed this issue concerning the EMCCA region and regarding specifically the impact of the devaluation on the balance of trade of the EMCCA countries. In other to bring our own contribution to scientific knowledge, we have decided to address this issue, with exclusive focus on the impact of the devaluation of the CFA Francs on the balance of trade of the EMCCA countries. This study focuses exclusively on the commercial transactions between the EMCCA countries and its commercial partners2 during the period 1980 to 2006. This period is being divided into two periods, the predevaluation period (1980 to 1993) and to postdevaluation period (1994 to 2006). Methodology and Data In this part of the paper, we explain the variables of interest that is the trade balance. The model used in this paper has been inspired by the equation on the balance of trade developed to study the effect of devaluation on the trade balance that occurred in Europe, under the fixed exchange rate regime of the European Monetary System, to evaluate the influence of the change in the exchange rate on the independent variables in question. Data Collection and Methods The data used in this research are secondary data, collected from various sources precisely from the CD ROM of CNUCED 2007, the World Development Indicator 2005 CD ROM, the World Bank Development Report CD-ROM (1978-2006) where we collected the data of EMCCA principal economic partners. In the CD-ROM of the World Bank Africa Database 2006, where we collected the data concerning the growth of the GNP of the EMCCA countries, the share of the monetary base on GNP in the EMCCA countries; and finally the Bank of France annual Statistical report on CFA zone where we collected the data related to the exportation and importation of goods and services in Central African Republic. Choice of Variables The external debt burden of Cameroon, Gabon, Congo, Chad, Equatorial Guinea, were respectively in millions of CFA Francs as follows: 45793.17 ; 1004916.79 ; 149811.26 ; 66745.42 ; 1335715.41. (Source: African Development Bank (ADB). 3 159 Available online at www.managementjournal.info Table 1: Presentation of the variables Measures Abbreviations Variables TB MO PU ER TC Source: Thiry [2] In this research we use the double least square method to estimate our parameters. The dependent (explained or endogenous) variable of our study is the trade balance of the EMCCA countries while the other variables are independent (explanatory or exogenous) variables. All the independent variables were constructed using its ratio relative to the GNP of the EMCCA countries, as well as for the variable concerning the economic partners of the EMCCA countries. This method presents the advantage of reducing the risk of non-stationary of the series, taking into consideration the international context in the variation of the independents variables [2]. Method of Estimation Panel data (also known as longitudinal or crosssectional time-series data) is a data set in which the behaviours of entities are observed across time. Panel data or longitudinal data are used when we are in the presence of a regression model in which observations are carried out on many individuals at different time periods [24]. In this article, the individuals (EMCCA3 counties) are graded from 0 to 6, while the time period goes from 0 to 13 for the pre-devaluation periods and goes from 0 to 12 for the post-devaluation periods. The reason for using panel data in this research is because it enables us to use many parameters at once thereby increasing the degree of freedom of our model and also panel data takes into consideration the heterogeneity of our observed variables and facilitates the test of more complicated models while reducing the bias of the coefficients and observed parameters [25]. In this research we carry out three tests: • The P-value test • The augmented Dickey-Fuller test • The coefficient of determination R² • The statistical software used to estimate our model is Eviews 3.1 Presentation of the Model 4 We understand by commercial partners, all the countries that undertake commercial transaction with EMCCA countries (taking consideration that EMCCA is an economic entity because sharing a unique currency the CFA Franc). Namely: European Union, USA, Brazil, CDEAO, Nigeria, Morocco, Egypt, Algeria, Canada etc. 5EMCCA countries are : Cameroon, Chad, Gabon, Central Africa Republic, Equatorial Guinea and Republic of Congo Nembot Ndeffo Luc et. al.| July.-Aug. 2012 | Vol.1 | Issue 4|157- 164 The Trade balance to GNP ratio The monetary base to GNP Government consumption to GNP ratio The CFA Franc exchange rate The GNP growth rate ! # " $% &' &( )*$% *+% , &- )./$% ./0% , &1 )23$% 230% , &4 5+$% 6$% 777 89: 77 Represents trade balance in country i at t year, ; represents GNP in country i at t year. 7 and represent respectively the growth rate of GNP in country i at t period and in the economic partner countries of the EMCCA countries. and represent respectively the monetary base in country i at t period and in the economic partner countries of the EMCCA countries. and represent respectively the government expenditure in country i at t period and in the economic partner countries of the EMCCA countries. and µ , α7 ε 7 β τ ,7γ777777 δ represent respectively the CFA Franc exchange rate vis-àvis the USA Dollars and the error terms; while < 7 = > 7 ? @ A are parameters to be determined. Results and Discussions While interpreting the results of the statistical test, a short commentary on the statistical test is made. Statistic Test The p-value observed with a value smaller than 5% shows that the variables in consideration are significant, while the tstatistics gives us the sign and the level of significance of the variables in question. Taking into consideration the values in table 3, we notice that the GNP growth rate after the devaluation of the CFA Franc is significant since it is less than 5% {P (BCDE BCFE ,= 0.1489≺5%}; the sign of the t-statistic is positive meaning that, the GNP growth rate in the EMCCA countries had a positive influence to improve the trade balance account in the EMCCA countries after the devaluation of its currency, reason why we accept the null hypothesis which states that devaluation of a currency improves its trade balance. The Augmented DickeyDickey-Fuller Unit Root Test 160 Available online at www.managementjournal.info Table 2: The PP-Value test and the tt-statictics for the balance of trade before the devaluation of the CFA Franc Variables The Passnormality t-Statistics Sign Conclusion Passnormality normity test normity test« test« pvalue » Reject KL 0.0000 yes 6.867030 Positive BCHI BCJI MNDE MNFE 0.0000 yes 13.03220 Negative Reject KL OPDE 0.0000 yes 6.712176 Negative Reject KL QRDE QRFE 0.0007 yes 3.542019 Positive Reject KL Source: Estimated results Dependent Variable: TB Method: Panel Two-Stage Least Squares Date: 13/06/09 Time: 11:18 Sample (adjusted): 1981 1993 Cross-sections included: 6 Total panel (unbalanced) observations: 72 White cross-section standard errors & covariance (d.f. corrected) Instrument List: C TC (-1) TC (-2) PU (-1) ER MO (-1) MO (-2) PU TB Variable Coefficient Std. error t-Statistic Prob. TC (-1) MO PU (-1) ER TB 0.481177 -2.534883 0.289575 -0.068165 56.31252 0.070071 0.194509 0.081754 0.010155 39.08390 6.867030 -13.03220 3.542019 -6.712176 1.440811 0.0000 0.0000 0.0007 0.0000 0.1543 R-squared S.E. of regression Durbin-Watson stat Instrument rank 0.581910 22.00436 2.131883 12.00000 Mean dependent var Sum squared resid J-statistic -45.55389 32440.85 67.00000 Table 3: the PP-Value test and the tt-statistics for the balance of trade after the devaluation of the CFA Franc Variables The normality test Pass normality t-Statistics Sign Conclusion « p-value » test 0.1489** No 1.474126 Positive BCHI BCJI Accept KS MNHI MNJI OPHI 0.0065 0.1158** yes No -2.882318 -1.610457 Negative Negative Reject KS Accept KS QRHI QRJI 0.0000 yes -5.038256 Negative Reject KS Source: Estimated results Dependent Variable: TB Method: Panel Two-Stage Least Squares Date: 13/06/09 Time: 12: 11 Sample (adjusted): 1999 2005 Cross-sections included: 6 Total panel (balanced) observations: 42 Instrument list: TC C TC (-1) ER PU MO TB (-5) TC (-4) ER (-1) MO (-1) Variable Coefficient Std. Error t-Statistic Prob. TC (-4) -12001.40 6910.800 -1.736615 0.0908 TC (-5) 0.229725 0.155838 1.474126 0.1489 ER -0.021078 0.013088 -1.610457 0.1158 PU -97.88806 19.42896 -5.038256 0.0000 MO -22.42125 7.778894 -2.882318 0.0065 Nembot Ndeffo Luc et. al.| July.-Aug. 2012 | Vol.1 | Issue 4|157- 164 161 Available online at www.managementjournal.info R-squared 0.743701 Mean dependent var -15.36602 Adjusted R-squared 0.715993 S.D. dependent var 27.84006 S.E. of regression 14.83661 Sum squared resid 8144.624 Durbin-Watson stat 2.016873 J-statistic 35.35210 Instrument rank 11.00000 The augmented Dickey-Fuller test was used to test the unit root and at the end we found out that, the probability of the augmented DickeyFuller test and the Fisher Chi-square test was (0.0392) inferior to 5% threshold that we chose. We concluded that the model is stationary; meaning that in our model used in this paper, the null hypothesis of the unit root test is not rejected. Coefficient of Determination TTT The and represents respectively the coefficient of determination and the adjusted coefficient of determination. These coefficients permit us to appreciate the degree of relationship between the explained and the explanatory variable. Our results show that the and TTT are relatively higher in nominal values in the model after the devaluation of the CFA Franc currency than in the model before the devaluation of the CFA Franc currency. Economic Interpretation Our results show that there is a negative relationship between exchange rate, the monetary base, and the trade balance in the EMCCA countries. This means that the devaluation of the CFA Franc boosted export in the EMCCA subregion. In our equation this is reflected in such a way as to say that, if trade balance has to increase by one unit, the exchange rate must reduce by 6.8%. Obviously we notice that there is a positive relationship between trade balance and the other variables of our model namely the GNP growth rate and government expenditure. Thus to increase trade balance by a unit, the GNP growth rate and the per capital government expenditure must increase respectively by 48% and 29%. This is shown in the table below. After the devaluation of the CFA Franc, we notice from our estimates that the sign of the government expenditure parameter changes from a positive to a negative sign. This is a significant result because it proves that after the devaluation of the CFA Franc, an increase in government expenditure results immediately to a deterioration of the trade balance while a reduction in government expenditure result instead to an improvement in the trade balance. This is easily verified in EMCCA economies because the greatest share of public expenditure Nembot Ndeffo Luc et. al.| July.-Aug. 2012 | Vol.1 | Issue 4|157- 164 is allocated to imports of goods. Thus the consumption of local produced goods leads automatically to the improvement of the trade balance account. While focusing on the exchange rate, we conclude from our estimates that a fall of 2.1% in the exchange rate results to an improvement of the trade balance by a 100%. Though this results’ level of significance is not too high, it enables us to conclude that the devaluation of the CFA Franc resulted to an improvement of the trade balance account in the EMCCA region. Further more, the positive sign of the GNP growth rate observed in our estimation shows that though the EMCCA economy’s industries depend mostly on the importation of raw materials in the production of their final goods, this does not deprive these industries from contributing to the improvement of the balance of trade account in the EMCCA region. Conclusion and Recommendations This research aimed at appreciating the impact of the devaluation of the CFA Franc on the trade balance account of EMCCA countries. The methodology used in this research is that of panel data, since this study encompasses six countries of the EMCCA region. Results at the end show that the effect of the 1994 devaluation of the CFA Franc on the trade balance account in the EMCCA countries were positive, but not enough to meet the set objectives. Our results show that the devaluation of the CFA currency has improved the competitiveness of the EMCCA countries’ economy and had also improved the trade balance of the EMCCA countries; but not up to the level expected by policy makers in other to foster a desirable trade balance account of the countries; as was propounded by most economic analyst, while trying to explain the benefits of such economic policies which according to them will pull the EMCCA countries out of the economic slump of the eighties. Although the devaluation of the CFA had had a positive impact on the trade balance of the EMCCA countries, their effects had been dissolved over time, because of misleading economic policies and principally because of the fluctuation of the CFA franc with respect to the U.S. Dollar. These results pushes us to formulate some recommendations. • Incentives should be set up in the EMCCA countries in other to stimulate local 162 Available online at www.managementjournal.info Table 4: Influence of the signs of explained variables on the explanatory variable before the devaluation BCDE MNDE QRDE OPDE X BCFE MNFE QRFE BUDE 0.481177 -2.534883 0.289575 -0.068165 Source: Estimated results Table 5: Influence of the signs of explained variables on the explanatory variable after the devaluation BCDE MNDE QRDE X BCFE MNFE QRFE BUDE 0.229725 22.42125 -97.88806 OPDE 0.021078 Source: Estimated results Note: Y represents the endogenous variable while X represents the exogenous variables. • consumption and intra regional trade. These incentives could be materialised in the form of infrastructure construction such as road communication facilities such that there will be a real free movement of people and goods. By so doing these will reduce import and thereby improve trade balance within the EMCCA zone. The different government of the EMCCA countries should change their mode of government expenditure that is focused principally on importation which renders our economies vulnerable to external shocks. More emphasis should be put on the fight against “institutional corruption” in other to enable the emergence of economic yielding project still in the coffers. Doing so will create employment, stimulate economic growth and leads the countries towards development. Therefore the EMCCA economies will reduce it dependency toward developed economies. Taking a critical look at our result, we propose that the EMCCA economies should create its own currency. Doing so will enables these countries to decide on which monetary policies to undertake, such that these policy measures will make the EMCCA countries more independent in the management of their budgetary and monetary policies and they will be able to drive their economies where ever their profit lies. Having independence in the management of its currency will relief the EMCCA countries of some severe external shocks like that of the financial crises that is crumbling the European economies nowadays. If the creation of a common currency specific to the EMCCA countries is not possible, we think the least to be done by the EMCCA monetary authorities and government is to rethink its exchange system and join a floating exchange rate system. References 1. Zacharie Arnaud (2000) Franc CFA et néocolonialisme monétaire »Texte disponible sur http://www.google.fr (fonctionnement de la zone Franc.) Consulted the 1/02/2007. 2. 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