Plans for a West African currency union are underway and by 2020 six countries, including Nigeria, could be swapping their currencies for a new one – the Eco. Monetary policy has been a struggle for Nigeria lately; a recent article collated the complaints of Nigerian economists, some of whom blame the CBN for moving Nigeria’s economy from frying pan to fire. Could a new currency union be the panacea?
Aside from the trade discussion in part I, there are considerable economic implications of a currency union. Notably, Nigeria would lose a large chunk of its monetary autonomy to a new regional central bank. Even if the CBN were to remain in existence, it would have a very limited role. Like the European Central Bank (ECB), the regional central bank would be charged with dictating monetary policy for the bloc, including setting interest rates and regulating the money supply. The primary debate here is whether the benefits of a currency union will be enough to offset this loss of autonomy.
In some ways, the push for a new ECOWAS (Economic Community of West African States) currency union looks more like a collective short-term fix than a long-term strategy. One persistent challenge these countries face is the lack of central bank independence. The International Monetary Fund (IMF) gives Nigeria a score of 0.44 on its independence index, slightly below the African average of 0.47. This is unsurprising given the likely role of political pressure in pegging the naira despite a growing case for greater exchange rate flexibility. But this scenario is problematic as economic theory explains how political influence and a compromised central bank can generate high levels of economic volatility. Governments are biased towards achieving economic growth so seek to exploit the temporary tradeoff between national demand and inflation to boost the economy. But this boost is temporary and mainly leads to high levels of inflation in the long-run.
A regional central bank would be able to act more independently – free from the grasp of interfering political and fiscal authorities. One example is the CFA franc currency unions run in West and Central Africa. The central banks serving these unions both attain very high scores on the IMF independence index, with the Central Bank of the West African States scoring 0.63.
This independence is important for credibility, one of the most valuable qualities of a central bank, and a key consideration in monetary policy. The credibility of the ECB enabled President Mario Draghi to save the Euro with a single phrase. Godwin Emefiele's words are unlikely to have a similar effect.
A Euro Crisis Lesson
But caution must be applied. The proposed currency union faces one very difficult challenge – effectively coordinating fiscal and monetary policy. At the moment, the fiscal and monetary policies of a country are conducted by the Federal Government and Central Bank, respectively. Though ostensibly independent, both are operating within the same borders, are faced with identical economic conditions, and have the same long-run goal: the sustainable economic prosperity of the nation.
A currency union would work rather differently as the regional central bank would be focused on the entire regional bloc. In directing monetary policy, it would consider variables in multiple countries, many of which are likely to conflict. This could lead to inconsistencies between national fiscal policy and regional monetary policy. Furthermore, loss of monetary autonomy could constrain or compel more extreme fiscal action. The Eurozone famously suffered from this problem in the wake of the Great Recession as countries such as Greece and Portugal turned to aggressive expansionary fiscal policy, leveraging on the low interest rate environment created by the ECB. The result was the Eurozone Debt Crisis with Greece in the eye of the storm.
One solution to this tension is by allowing greater fiscal integration. For the Eco to work, this must be considered. But this is problematic in itself as Nigeria's fiscal authority is still developing and the same can be said about the other prospective Eco countries. In fact, the instability of the fiscal environment within the region – spontaneous tax changes and inconsistent budget implementation – would only serve to worsen things. Asking the country to coordinate fiscal policy with five others would be a tall order.
In the absence of a corollary fiscal or political union, common fiscal rules would need to be applied to prevent similar crises. But even when such rules are applied, they are often broken, usually with significant ramifications. Greece, a country that represents about 2% of the Eurozone, nearly led to the collapse of the currency union as a result of its fiscal indiscipline. Once again, a similar risk exists with the Eco, especially as West African countries are not known for their discipline and cooperation.
No Currency or The Notorious Naira
The loss of monetary autonomy should be explored further. A currency union means Nigeria loses the ability to print its own currency or set interest rates, both important monetary policy tools.
Moreover, the exchange rate may cease to act as an automatic stabiliser. Usually, when a country is hit by an adverse economic shock, a floating currency will depreciate as traders sell the currency and investors exit. This erosion in currency value will improve the competitiveness of the country's goods (exports are cheaper, imports are costlier) and, depending on the price elasticity of traded goods, net exports should rise to counteract the adverse shock. This process may not happen in a currency union if the shock is concentrated as the exchange rate will not adjust. For example, if Greece operated its own currency, it could have allowed it weaken to increase international competitiveness and boost aggregate demand. This is what happened in Iceland.
However, considering the state of the naira, swapping it for the Eco might just be a good deal. Currently, the naira can be exchanged at almost six different rates. Meanwhile, there is still confusion over whether the currency is fixed, floating, or dirty floating. The new currency union can provide coordination and move West Africa towards a healthy exchange rate system that is easily convertible internationally.
Additionally, individual West African countries are very susceptible to changes in monetary policy of advanced economies due to different pegs. This unhealthy volatility and steady capital outflow have hurt countries such as Ghana and Nigeria in recent times. The Eco is likely to be more stable and wield greater international influence. Stronger regional macroprudential policies can be set, which would protect the region from volatility in capital movements and other shocks.
Ultimately, We do not need to join a currency union to fix these problems. Nigeria should be able to address its credibility and exchange rate challenges alone. The strategic case for the Eco is mixed at present, but it is clear that it cannot be seen as a silver bullet to address contemporary problems. In the awkward fashion of recent monetary policy action in Nigeria, Minister of Finance Kemi Adeosun and Vice President Yemi Osinbajo have recently spoken about addressing some of these problems. A good start would be moving towards a uniform exchange rate. This should get the naira back on track and recede cravings for the Eco.