Annual Conference on Regional Integration in Africa (ACRIA 4) Private Sector Development and Job Creation in West Africa Abidjan 4-5 July 2013 The Quest for a Monetary Union in ECOWAS: An Econometric Test for Convergence of Countries By Mohamed B.O Ndiaye and Robert Dauda Korsu WEST AFRICAN MONETARY AGENCY

OUTLINE OF THE PRESETATION 1. Introduction 2. Literature 3. Methodology 4. Empirical Results 5. Conclusion 6. Recommendations

1. Introduction Interest in, and effort at Monetary Integration in ECOWAS is not a new issue in the ECOWAS region. There has been great effort by various stakeholders. Recognising the importance of economic integration, the ETLS, CET and ECOWAS Protocol on Free Movement of goods and persons and right of establishment are being promoted by the various member countries, in spite of various challenges

1. Introduction Monetary Integration within Economic Integration: The Traditional Stages- Free Trade Area, Customs Union, Common Market, Monetary Union, Economic Union ECOWAS STEPS: ETLS, CET, ECOWAS Protocol on Free movement of goods and persons and right of establishment, The Single Currency Project

1. Introduction EMCP was adopted in 1987: To have a common currency in the ECOWAS countries Target dates: Observed postponements ( since 2000. The current date is 2020) Regular Activities: Multilateral Surveillance missions to assess member countries on macroeconomic convergence and some institutional arrangements and policy harmonisation issues Member countries meeting the primary convergence criteria on a sustainable basis and achievement of progress on the relevant institutional arrangements and policy harmonisation issues would pave the way for the common currency.

1. Introduction Status of Convergence Criteria: Countries that do well on the convergence criteria do not sustain it. Convergence Testing in General: THE BENCHMARK APPROACH and THE ECONOMETRIC APPROACH Currently in Use in ECOWAS The Approach of this study

1. Introduction Objective: To Investigate the Degree of Convergence among ECOWAS Countries Specifically, testing the degree of nominal and real convergence among: The Non-UEMOA Countries (with and without Cape Verde The UEMOA Countries and each non-UEMOA Country The ECOWAS countries as a group

2. Literature Convergence Testing: Common for Countries working towards integration Originally: The Catch Up Hypothesis ( β Convergence) Cointegration Tests ( Carmignani (2005), Testing Asymmetry of Shocks ( VAR)- Christodoulakis et al (1995) β Convergence ( Dramani , 2010) Testing partial and Full Convergence: Cointegration ( Johanson ML)- Rofael ( 2011)

3. Methodology Benchmark and Econometric Approach Nominal and Real Convergence Nominal convergence (convergence in nominal variables) is a necessary condition for a monetary union while real convergence ( convergence in real variable) is a sufficient condition Cointegration Approach: It points out whether there is no, partial or complete convergence Unit Root Tests--- Dicky Fuller GLS Tests Cointegration Tests– Johanson MLE ( It can provide information on partial and complete convergence)

3. Methodology Data (Sources: IFS, WDI, WAMA) Nominal Convergence: Nominal Exchange Rate ( Domestic Currency per U.S dollar), Interest Rate ( deposit rate), Reserve Money, Inflation Rate, Budget Deficit ( excluding grant) Quarterly from 2000Q1 to 2010Q4 Real Convergence: The Business Cycle ( Deviation of Real GDP from Trend)- Annual 1975 to 2010

4. Empirical Results In Tables 1 to 12, which follow we provided the results of the tests for nominal and real convergence

Table 1: Unit Root Tests on Exchange Rate Variable Implication Cape Verde EXR I(1) Cape Verde EXR Gambia EXR Gambia EXR Ghana EXR I(0) Ghana EXR Guinea EXR Guinea EXR Liberia EXR Liberia EXR Nigeria EXR  Nigeria EXR Sierra Leone EXR  Sierra Leone EXR UEMOA EXR UEMOA EXR On Exchange Rate, Ghana cannot be in Convergence with the Others

Table 2: Results of the Cointegration Test for Exchange Rate Convergence   Country Number of Individuals (1) Lags Included (2) Number of Cointegrating Vectors (3) Number of Common trend (4) = (1) - (3) Degree of Convergence (5) ALL WAMZ without Ghana 5 2 1 4 Partial WAMZ (without Ghana) plus Cape Verde 6 UEMOA+WAMZ without Ghana+ Cape Verde 7 3 UEMOA and Cape Verde Complete UEMOA Gambia None UEMOA Guinea UEMOA and Liberia UEMOA and Nigeria UEMOA and Sierra Leone

Table 3: Unit Root Tests: Interest Rate Variable Auxiliary Regression Contains Selected Lag Based on SIC Dickey-Fuller (ADF) GLS Statistics Implication Cape Verde INR Drift -1.6756 I(1) Drift and Trend -2.9313 Cape Verde INR -6.7713** -6.7764** Gambia INR 1 -1.8359 -1.8218 Gambia INR -3.9034** -4.0442** Ghana INR -1.9030 -2.0819 Ghana INR -4.1646** -4.1390** Guinea INR -1.3103 -0.6910 Guinea INR -6.3246** -6.4822** Liberia INR -1.6512 -2.4638 Liberia INR -7.9982** -7.8972** Nigeria INR -2.2863* I(0) -3.1900  Nigeria INR -3.9476** -4.0296** Sierra Leone INR -1.8373 -1.9317  Sierra Leone INR -4.0061** -4.1141** UEMOA INR -0.6376 -2.2764 UEMOA INR 2 -5.0140** -5.2861**

Number of Cointegrating Vectors Table 4: Results of the Cointegration Test for Interest Rate Convergence Country Number of Individuals (1) Lags Included (2) Number of Cointegrating Vectors (3) Number of Common trend (4) = (1) - (3) Degree of Convergence (5) ALL WAMZ without Nigeria 5 1 None WAMZ (without Nigeria) plus Cape Verde 6 4 UEMOA +WAMZ without Nigeria+ Cape Verde 7 2 3 Partial UEMOA and Cape Verde UEMOA Gambia UEMOA Guinea UEMOA and Liberia UEMOA and Ghana UEMOA and Sierra Leone

Table 5: Results of the unit root tests : Reserve Money (RSM) Variable Auxiliary Regression Contains Selected Lag Based on SIC Dickey-Fuller (ADF) GLS Statistics Implication Cape Verde RSM Drift -0.0372 I(1) Drift and Trend -2.7715 Cape Verde RSM 1 -6.2300** -6.3888** Gambia RSM 0.7738 -2.8105 Gambia RSM -7.6338** -7.7293** Ghana RSM 2.2214 -1.0051 Ghana RSM -5.0217** -5.4303** Guinea RSM 0.1616 -1.4554 Guinea RSM -8.4168** -8.7392** Liberia RSM 2 2.1124 0.2055 Liberia RSM -0.8467 -5.8157** Nigeria RSM 1.3985 -2.6935  Nigeria RSM -9.2396** -9.6662** Sierra Leone RSM 3.0915 -0.7047  Sierra Leone RSM -5.0268** -5.2613** UEMOA RSM 1.7502 -1.7672 UEMOA RSM -6.8031** -6.9772**

Number of Cointegrating Vectors Table 6: Results of the Cointegration Test for Reserve Money Convergence Country Number of Individuals (1) Lags Included (2) Number of Cointegrating Vectors (3) Number of Common trend (4) = (1) - (3) Degree of Convergence (5) ALL WAMZ 6 4 2 Partial WAMZ plus Cape Verde 7 3 UEMOA+WAMZ+Cape Verde 8 UEMOA and Cape Verde 1 None UEMOA and Gambia UEMOA and Ghana UEMOA and Guinea UEMOA and Liberia UEMOA and Nigeria UEMOA and Sierra Leone

Table 7: Results of the unit root tests : Inflation Rate (INF) Variable Auxiliary Regression Contains Selected Lag Based on SIC Dickey-Fuller (ADF) GLS Statistics Implication Cape Verde INF Drift 1 -3.0305* I(0) Drift and Trend -3.3909 Cape Verde INF -3.0512** -3.7822** Gambia INF -1.7912 I(1) -2.0754 Gambia INF -4.3849** -4.4202** Ghana INF -1.7800 -3.4012* Ghana INF -3.1308** -3.2940* Guinea INF -1.9405 -2.1887 Guinea INF -2.3920* -2.4218 Liberia INF -2.0123* -3.6426* Liberia INF -2.4109* -2.7279 Nigeria INF -3.0455** -3.6316*  Nigeria INF -4.9259** -5.1015** Sierra Leone INF -1.0866 -2.9034  Sierra Leone INF -3.7999** -4.6276** UEMOA INF 2 -5.0517** -4.9918** UEMOA INF -2.7355** -2.8290

Table 8: Results of the Cointegration Test for Inflation Rate Country Number of Individuals (1) Lags Included (2) Number of Cointegrating Vectors (3) Number of Common trend (4) = (1) - (3) Degree of Convergence (5) WAMZ without Ghana, Liberia and Nigeria 3 2 1 Partial WAMZ (without Ghana, Liberia and Nigeria) plus Cape Verde 4 Testing is not meaningful as Cape Verde has an I(0) inflation rate None UEMOA+ WAMZ ( without Ghana, Liberia and Nigeria )+ Cape Verde 5 Testing is not meaningful as UEMOA and Cape Verde have I(0) inflation rates UEMOA and Cape Verde Testing is not meaningful. UEMOA and Gambia UEMOA Guinea UEMOA and Liberia UEMOA and Nigeria UEMOA and Sierra Leone

Table 9: Results of the unit root tests : Budget Deficit (BDF) Variable Auxiliary Regression Contains Selected Lag Based on SIC Dickey-Fuller (ADF) GLS Statistics Implication Cape Verde BDF Drift 1 -1.5119 I(2) Drift and Trend -1.5423 Cape Verde BDF -1.5845 -2.6450 2Cape Verde BDF -8.0114** -8.0329** Gambia BDF -2.0691* I(0) -2.5052 Gambia BDF -1.9929* -2.6327 Ghana BDF -3.0745** 2 -3.8325** Ghana BDF -2.1365* -2.7923* Guinea BDF -2.4070* -2.9092 Guinea BDF -2.2411* -2.5234 Liberia BDF -3.5846** -3.6198* Liberia BDF -2.4274* -2.6640 Nigeria BDF -1.8402 -2.0143  Nigeria BDF -1.6413 -2.0642 2 Nigeria BDF -7.4258** -8.1609** Sierra Leone BDF -1.3445 I(1) -1.4821  Sierra Leone BDF -3.1217** -3.3371* UEMOA BDF -2.0485* -2.3052 UEMOA BDF -2.7477 -2.8496

Table 10: Results of the Cointegration Test for Budget Deficit Country Number of Individuals (1) Lags Included (2) Number of Cointegrating Vectors (3) Number of Common trend (4) = (1) - (3) Degree of Convergence (5) WAMZ without Gambia, Ghana, Guinea and Liberia ( That is, Nigeria and Sierra Leone) 2 None WAMZ (without Gambia, Ghana, Guinea and Liberia) plus Cape Verde 3 1 Partial UEMOA+ WAMZ ( without Gambia, Ghana, Guinea and Liberia)+ Cape Verde 4 Testing is not meaningful as budget deficit for UEMOA is I(0) UEMOA and Cape Verde Testing is not meaningful. UEMOA and Gambia UEMOA Guinea UEMOA and Liberia UEMOA and Nigeria UEMOA and Sierra Leone Testing is not meaningful

Table 11: Results of the unit root tests : Business Cycle (BCY) Variable Auxiliary Regression Contains Selected Lag Based on SIC Dickey-Fuller (ADF) GLS Statistics Implication Cape Verde BCY Drift 1 -1.0951 I(1) Drift and Trend -0.9458 Cape Verde BCY -1.4292 -3.2395** Gambia BCY 0.0335 0.2457 Gambia BCY -3.9933** -5.5523** Ghana BCY -1.1139 2 -0.7349 Ghana BCY -0.0757 -4.0965** Guinea BCY -1.1800 -1.1977 Guinea BCY -5.7392** -6.3749** Liberia BCY -1.2223 -1.3134 Liberia BCY -3.3903** -3.6976** Nigeria BCY 3 -1.6221 I(2) -1.5080  Nigeria BCY -0.9954 -2.1245 -2.9168** -9.1464** Sierra Leone BCY -1.3960 -1.4188  Sierra Leone BCY -4.1534** -4.5626** UEMOA BCY -0.8229 (1) -0.8970 UEMOA BCY -2.9158** -3.9855**

Table 12: Results of the Cointegration Test for Business Cycle Convergence   Country Number of Individuals (1) Lags Included (2) Number of Cointegrating Vectors (3) Number of Common trend (4) = (1) - (3) Degree of Convergence (5) ALL WAMZ 6 1 2 4 Partial WAMZ plus Cape Verde 7 3 UEMOA+WAMZ + Cape Verde 8 UEMOA and Cape Verde None UEMOA Gambia UEMOA Guinea UEMOA and Liberia UEMOA and Nigeria UEMOA and Sierra Leone

5.Conclusion Nominal Convergence ( Exchange Rate) There is convergence though partial among (i) the WAMZ countries ( without Ghana) (ii) the WAMZ countries and Cape Verde but ( without Ghana) (ii) the ECOWAS countries as a whole, without Ghana and (iv) UEMOA and Cape Verde ( a complete convergence case). There is however, no convergence among the UEMOA and any of the other non-UEMOA countries. Nominal Convergence ( Interest Rate) There is convergence only in the case of all the ECOWAS countries, without Nigeria ( partial convergence). There is however, no convergence among the UEMOA and any of the other non-UEMOA countries Nominal Convergence (Reserve Money), All the WAMZ countries are in partial convergence, the WAMZ and Cape Verde are in partial convergence, all the ECOWAS countries are in partial convergence. None of the non-UEMOA countries is however in convergence with the UEMOA countries.

5. Conclusion Nominal Convergence (Budget Deficit) Budget deficit the WAMZ countries ( with or without Cape Verde) are not in convergence. However, Sierra Leone, Nigeria and Cape Verde are in partial convergence. The ECOWAS countries as a whole are not in convergence and none of the non-UEMOA countries is in convergence with the UEMOA. Nominal Convergence (Inflation) There is partial convergence among Gambia, Guinea and Sierra Leone but no convergence among the whole WAMZ, the whole of ECOWAS or WAMZ plus Cape Verde. Moreover, none of the non-UEMOA countries is in convergence with the UEMOA countries in terms of inflation. Real Convergence ( Business Cycle) There is partial convergence among the WAMZ countries, the WAMZ countries and Cape Verde and ECOWAS countries as a whole. There is however no real convergence between the UEMOA and any of the non-UEMOA countries.

6. Recommendations The existence of real convergence as well as nominal convergence, in terms of reserve money, of the WAMZ countries as well as the ECOWAS countries as a whole suggests that the WAMZ countries or the ECOWAS countries as a whole may opt for a single currency framework as long as the relevant policy harmonisations and institutional arrangements are in place. To the extent that there is no convergence on the budget deficits of the WAMZ countries and the ECOWAS countries as a whole, a currency union in the region should be tied to a strong clause in relation to commitment to a common fiscal rule in respect of expenditure rationalisation and revenue mobilisation targets and mechanism. The national and ECOWAS parliaments may be useful in this regard in an effort to monitor domestic compliance with regional fiscal targets.  

6. Recommendations There is no convergence at the WAMZ level or the ECOWAS level as a whole on the inflation rate. It is therefore important that a monetary union from the region takes low and stable inflation as the ultimate objective of monetary policy while financial sector stability interest would continue to be pursued. The non-existence of convergence in the interest rates among the WAMZ countries as well as the ECOWAS region as a whole suggests that it is necessary to have a common money market and monetary policy rate under a single currency zone from the region.

6. Recommendations The lack of convergence between the UEMOA and each of the non-UEMOA countries ( on individual basis) on interest rate, reserve money, budget deficit, inflation rate and the business cycle suggests that it is not optimal for any of the non-UEMOA countries to enter a monetary union on an individual basis with the UEMOA.

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