Download The Impact of the Devaluation of the CFA Franc on the Trade

ISSN: 22782278-3369
International Journal of Advances in Management and Economics
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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.
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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.
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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
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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.
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[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
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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
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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
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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
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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
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Arnaud
(2000)
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