Monetary and Financial Systems in Africa

This chapter presents the evolution of monetary regimes and financial institutions in Africa from the colonial era and changes after independence that were spurred by the quest for sovereignty and a new path for development financing.  Nevertheless, such changes are less common in the CFA franc countries. The chapter further discusses the components of the monetary and financial systems and shows how they are indispensable in changing the economy’s structure and enhancing economic performance. They facilitate economic activities and growth by reducing transaction, information, and enforcement costs. The digital revolution is also transforming financial institutions. The chapter uses lessons from an Indian case study to demonstrate the role of the monetary institution in poverty reduction and development. The chapter stresses Africa’s excellent manufacturing potential, which so far is not adequately exploited. The chapter emphasizes the importance of African policymakers focusing on Africa’s industrialization because of its potential to bring about continental prosperity. The chapter concludes with an overview of monetary regimes or arrangements in Africa and assesses the effectiveness of the different monetary systems on the development of African economies.

The fact that price stability is at the core of monetary policy frameworks of central banks in Africa is well known. However, whether this price stability objective has been served and how other macroeconomic and welfare conditions have fared as a consequence remains an important consideration that has not been given careful thought in the literature. Using Ghana, an inflation- targeting country, as a case study, we assess the price stability performance and other macroeconomic developments and imperatives to address whether the intended objectives and actual outcomes are in sync, with hard and soft nose as a framework. We find that inflation has been low and stable under the inflation targeting regime. However, the constant breaches of the publicly announced inflation targets do dent the credibility of the monetary authorities and shake the very foundation of the inflation-targeting framework. Still, it also raises serious questions about the quality of the forecasting framework of the Central Bank and the nature of assessments that feed into the target determination. Important policy issues are discussed.

The study examines the impact of monetary policies on economic growth in Sierra Leone using time series data for 1980–2019. Specifically, the study determines how changes in monetary policy transmission through interest rates, reel effective exchange rate, credit to the private sector, and lending rates affect real GDP growth in the country. The relationship between real GDP and monetary policy variables is estimated using the Fully Modified Ordinary Least Square regression. The approach addresses the problem of endogeneity and serial correlation by allowing heterogeneity in the long-run parameter estimates. The diagnostic tests for unit root and cointegration revealed a long-run relationship among the variables, thus indicating a long-run equilibrium relationship. The results from the study show the strength of monetary policy interventions in promoting economic growth in Sierra Leone through real effective exchange rates and monetary sector credit to the private sector. The study also reveals that inflation and interest rate had the expected negative signs but are not effective monetary policy transmission channels. Understanding the effectiveness of how monetary policy channels work in Sierra Leone is critical for policy implementation that enhances output growth.

This chapter aims to analyze the efficiencies of the monetary union project in West Africa. Specifically, the aim is to analyze the current economic conditions for the viability of the ECOWAS monetary zone, highlighting the situation of the various components of this monetary cooperation. The results based on recent statistics show, on the one hand, a deterioration in the profile of macroeconomic convergence with a downward trend in the number of countries that meet all the criteria, and on the other hand, there is little progress in the harmonization of economic policies. Thus, the convergence of economic policies is weak and is not accompanied by a real and effective convergence of economies. Moreover, the cost-benefit analysis of participating in the monetary union project shows that the dynamic gains outweigh the costs in the long run, which would be transitory. Finally, for an effective monetary union, it is recommended: the consolidation of the economic union, the establishment of the fiscal union through the harmonization of fiscal policies, the unification of the banking system, the establishment of solid institutional frameworks, and structural policies for productive transformation and value creation.

The chapter draws on political economy to discuss the currency of the Economic Community of West African States (ECOWAS), to suggest ways of solving the issue of the union’s single currency. The region took a long time in settling on Eco as the name for its currency. ECOWAS initiated in 2000 the idea of a single currency. After elaborate preparation to launch the Eco in 2020, the French-speaking ECOWAS member states appropriated Eco in 2019. Hence, the non-French ECOWAS members strongly disapproved because they regarded the appropriation as a betrayal. The non-French ECOWAS countries are seeking a single currency solution in the region. The chapter utilizes the interest group political approach of Mark Roe, Gourevitch, and Shine to determine channels of the political influence of monetary integration in ECOWAS. The chapter highlights the impact of historical differences between the CFA Franc ECOWAS members and the rest of the ECOWAS. It further re-examines France-Afrique monetary relationship and difficulties restructuring African countries’ relationship. Finally, the chapter analyzes three main options and suggests a viable measure to rebuild trust among French and the other ECOWAS member states towards a single ECOWAS currency.

The chapter analyzes the effect of minimum bank capital on the financing of the CEMAC economies over 1998–2016, using data from BEAC and COBAC. Commercial banks operating in that zone are reluctant to finance local small and medium enterprises (SMEs). In December 2019, SMEs received 14.6% of total loans, while big companies obtained 78%. So, their analysis is on the effect of the minimum bank capital on the real cost of credit, the credit term structure, and the various economic agents. Their findings, among other things, show that: (i) the minimum bank capital is positively and significantly linked to the total credits to the economy; (ii) the minimum bank capital is negatively associated with the short-run loans. The study suggests that regulatory authorities find ways of encouraging banks to increase the level of business financing sharply.

This chapter shows how the East African Monetary Union can be successful and sustainable. We examine the structural attributes of the East African Community member countries that can potentially affect the progress of the monetary union. We use data provided by the World Bank and review some reports and journal articles to demonstrate the lack of convergence in some macroeconomic variables among member states. To be more specific, structural similarities are only exhibited with inflation but, countries diverge, among other things, in exchange rates, interest rates, banking, public debt sizes, and trade. We end the chapter by recommending that East African Monetary Union member states work toward harmonizing monetary and fiscal policies and increasing their collaboration in other macroeconomic indicators like trade and debt management.

The chapter traces the evolution of the CFA franc and the special arrangements between franc zone countries and France, including the 1999 Euro of the European Union and the origin of the French banking system in the African colonies. It ascertains factors that have inhibited economic growth to find ways of addressing those factors. It utilizes literature review and tables based on data drawn from BCEAO, World Bank, WTO, CEMAC, COBAC, and UEMOA. Hence, the chapter examines the central factors, including institutional rigidity, foreign reserve restrictions, lack of monetary policy, and exchange rate policy, that have negatively affected the economic growth and development in the CFA franc zone countries. It demonstrates that arrangements superficially have appeared to provide some advantages. Still, the institutional financial features embedded in the arrangements have hindered the more rapid and sustained growth in the CFA franc zone economies. A vital component of the financial system is the banking system which has been fundamentally and predominantly French-based.

Furthermore, the chapter analyses the factors that have affected the different aspects of the economies of CFA franc countries and limited the region to producing and exporting mainly raw materials. Despite the longevity of the CFA franc arrangement, the zone remains a producer of raw materials with limited financial opportunities for the development of the private sector and financing economic activities. Accordingly, the chapter suggests ways in which the region can carry out structural transformation with changes in the production structure of these economies, diversify the economies and promote regional trade. As important as they are, these changes must come about with total monetary and financial systems changes.

This chapter presents the evolution of banking in West Africa, focusing on ties of the West African Economic and Monetary Union (WAEMU) countries to their French colonial heritage and non-WAEMU countries to their British heritage. It includes an overview of the sub region’s financial development and goes beyond to analyze the factors that determine financial development, focusing on the development of the banking sector. The random-effects and fixed-effects models were estimated to determine the factors that account for changes in banking development using panel data for 2007–2017. The results show that governance indicators such as the control of corruption, and regulatory quality, apart from GDP per capita and the interest rate spread, significantly determine banking development. The proxies for banking development include domestic credit to the private sector as a percentage of GDP, bank liquid reserves to bank assets, claims on the central government as a percentage of GDP, and bank branches per 100,000 adults, informing on financial depth, financial access and stability.

The study uses panel data for the period 2010–2021 to determine whether there is a long-run cointegration relationship between real output growth and capital market development in, Egypt, Morocco, and Tunisia. Using the ARDL and the Markov Switching Regression, the study finds that capital market development measured with market capitalization is positively and significantly related to real GDP growth in the selected North African countries. The error correction term is negative and significant, indicating the subsequent corrections of the deviations of real GDP growth from the long-term value. The paper suggests the need for an expansion and enhancement of capital markets in financing the economies of the selected countries.

The chapter reviews the recent literature on the economic integration and economic performance nexus. Then, it discusses trends in the economic performance of the African regional economies by analyzing the possible financial integration and economic performance nexus. Finally, the chapter aims at providing lessons for government and policymakers to facilitate better, more accurate, and informed decision-making around their participation in financial and economic integration. Further to the introduction, the remainder of the chapter has three sections: a discussion of the theoretical and empirical economic integration and economic performance nexus in section “Theoretical and Empirical Literature on Effect of Monetary Unions on Economies”. Section reviews “Empirical Literature”, using data from international sources (UNDP, Human Development Indicators, and World Bank’s World Development Indicators), reviews the economic performance within and across the regional economies. Economic growth performance, GDP per capita, Exports and Imports, GDP, Foreign Direct Investment flows, and Human Development performance are the leading indicators in examining a nexus with financial integration. Section “The State of Integration as a Pathway to Monetary Unions in Africa” highlights the main challenges of monetary integration; the final section will conclude with some policy recommendations.

The chapter discusses the issue of the limited African capital markets that constrain the development of Africa. The capital markets are underdeveloped and are thin. African capital markets have great potential but they are experiencing severe problems, including low capitalization, low liquidity, and a shortlist of participating companies on the stock exchange. There is, therefore, an urgent need for the right policies to speed the development of capital markets. Accordingly, the most urgent ones are the reinforcement of institutional capacity to enforce contracts and commercial regulations, the creation of electronic registry systems of property ownership, the reinforcement of monetary policy, the diversification of financial portfolio options, and the creation of secondary markets.

In this chapter, we investigate the international competitiveness of African countries in functional monetary unions. For the reason of data unavailability, the analysis focused on country levels as opposed to zone levels. Accordingly, four competitiveness indices (real effective exchange rate, export-gross domestic product ratio, export-import ratio, and technological development) were computed for the countries and their Eurozone counterparts in a comparative context. The African countries lagged the Europeans on the first three measures but outperformed on the technological development index. Conditional convergence appeared thus satisfied, raising the hope for a brighter future.

The Addis Ababa Action Agenda and the World Trade Organization recognize trade finance as essential for a healthy trading system and vital in implementing the Sustainable Development Goals. However, one of the factors that hinder trade expansion within Africa and between Africa and other parts of the world is a trade finance gap estimated at US$ 82 billion in 2019. Filling this gap means addressing the obstacles African banks face in expanding access to trade finance. To lighten the potential impact of COVID-19 on African trade and keep market access channels open, an uninterrupted supply of trade finance by banks is vital. There are myriad models of financing infrastructure, which include but are not limited to: private financing, official development assistance; national development banks; resource financed infrastructure; public-private partnerships as well as blended finance. Chinese financing for African infrastructure has been running at levels comparable to, or higher than, financing from all G7 members and multilateral development banks combined. In their efforts to set up financial facilities to support trade and infrastructure development, development finance institutions and governments should consider setting up rapid emergency facilities coupled with risk mitigation instruments earmarked to support banks as part of the solution.

Africa records low intra-regional trade, and much efforts have been made to encourage the regional blocs to trade among themselves to facilitate the continent’s growth. The main objective of this study was to estimate the effect of adopting a common currency on intra-regional trade in SACU and ECOWAS countries and to investigate whether countries were overtrading or under-trading among themselves using the Poisson Pseudo Maximum Likelihood (PPML) estimates. The study revealed that GDP, GDP per capita, and colonizer enhance trade in the two blocs. Adopting a common currency proved to unleash more trade potentials in the blocs. Distance exhibited a negative impact on trade in the two blocs, but exchange volatility showed a positive effect on trade in the SACU bloc but a negative effect in the ECOWAS bloc. The result further indicated that countries in the two blocs were under trading, but SACU had more trade potential than countries in the ECOWAS bloc. The study recommends that the ECOWAS countries achieve the nominal convergence to adopt the common currency to unleash the bloc’s trade potential. In addition, the SACU bloc was urged to pool more non-member countries to the SADC.

The chapter presents a historical and economic perspective of the proposed African single currency. It discusses the motivations for creating a monetary union and a single currency in Africa and evaluates its progress. Africa has drawn much inspiration from the European single currency experience that accounts for much of the progress in economic and monetary integration among members of the Eurozone. The Euro has proven to be an efficient means of conducting business transactions by participating countries, and the success is in part attributed to the high degree of convergence and homogeneity of the participating economies. However, African economies are diverse compared to European economies and need a different path to achieve monetary integration. A single currency in Africa will boost trade and economic cooperation among African Union members, thus stimulating growth and development. The chapter thus evaluates the benefits and costs of a monetary union and single currency and discusses the prospects for adopting a common currency in Africa. The African Union strategy towards economic and monetary integration emphasizes on strengthening existing regional economic communities and creating new ones that will eventually merge into an African Economic Community, an African Central Bank, and a single currency. The proposed African monetary integration will have extensive political and economic implications. Not all African countries will satisfy the stringent convergence requirements before the launching, but progressively, countries will get their macroeconomic policies and institutions up to the standards required to participate in the union successfully.

The chapter examines the steps that African Countries are taking towards monetary integration at sub-regional and continental levels. The aim is to have a single continental currency—the newly launched African Continental Free Trade Area (AfCFTA) is a precursor of the African Monetary Union. The AfCFTA became operational in January 2021 and, with a combined GDP of $3.4 trillion, is projected to be the largest free trade area in the world if implemented fully. The AfCFTA requires countries to reduce trade and non-trade barriers to allow for the free movement of goods, people with rights to live, establish and invest in any part of the continent.

Furthermore, the chapter demonstrates clear prospects and conditions for successfully building the African Monetary Union since monetary policy affects economic growth directly and indirectly through the transmission mechanism of credit to the private sector that promotes economic growth. At the same time, the key to the success of the proposed African single currency is to work towards the convergence criteria, including political and macroeconomic stability, but more importantly, having a prudent and responsible macroeconomic policy with a robust policy of credit access expansion.