1 OECD Development Centre Financing Costs and the CFA Franc: a Promise yet to be Fulfilled Nicolas Pinaud "Macroeconomic Policy in the Franc Zone: What can the European Central Bank learn from Africa?" February 21, 2006 Paris

2 OECD Development Centre Cost of Capital in the CFA Area: Expected Benefits A peg is conducive to a more stable real effective exchange rate (REER) –Fixed nominal exchange rate –Lower inflation

3 OECD Development Centre Cost of Capital in the CFA Area: Expected Benefits Reduced currency mismatch & lower solvency risk The bulk of ODA provided to UEMOA/CEMAC countries, and therefore the greater part of their external debt, are denominated in SDR, € and $

4 OECD Development Centre Cost of Capital in the CFA Area: Expected Benefits A lower (if not zero) currency-risk premium on local- currency denominated financing Breakdown of debt cost for a borrower in local currency on the local bond market Zero CFA / Euro Currency Premium

5 OECD Development Centre Cost of Capital in the CFA Area: Expected Benefits A lower (if not zero) currency-risk premium on local- currency denominated financing Fixed nominal exchange rate supp. of foreign investment (esp. from euro-zone investors in the CFA Zone) in LC denominated assets: no currency risk Low inflation theoretically conducive to higher domestic savings

6 OECD Development Centre Cost of Capital in the CFA Area: Expected Benefits A limited “transfer risk” (principle of free transferability) –Lower the solvency risk premium charged to non-sovereign entities –Makes it easier, in principle, for WAEMU / CAEMC corporations to "pierce" the sovereign ceiling –Transfer risk is usually a strong deterrent to foreign investment

7 OECD Development Centre Cost of Capital in the CFA Area: Expected Benefits Potentially, since 1999, an even larger capital pool accessible to CFA-zone entities: the Euro-zone –Quasi local-currency financing for CFA zone entities: no currency mismatch, i.e. lower solvency risk and default premium –One of the world broadest and deepest financial centre: high liquidity (no liquidity premium) and high appetite for risk –Top legal standards: no jurisdiction premium

8 OECD Development Centre Cost of Capital in the CFA Area: Mixed Outcome UEMOA countries' sovereign short term bond issues are gaining in importance (together with declining coupons) State-owned companies: BOAD, Port Autonome de Dakar, Communauté Electrique du Benin ☞ Average maturity of 7 years, 5.35% - 6.5% coupons Large UEMOA corporations are also issuing debt at relatively low cost: Nestlé (Ivory Coast), TELECEL (Burkina) and SHELTER Afrique (Senegal): ☞ Average maturity of 5 years and coupon between 6 and 7.25%

9 OECD Development Centre Cost of Capital in the CFA Area: Mixed Outcome However, local financial systems remain extremely shallow –Low domestic saving rates –Limited competition in the banking sector, limited role in the financing of the local economy

10 OECD Development Centre Cost of Capital in the CFA Area: Mixed Outcome However, local financial systems remain extremely shallow –Illiquid financial markets BRVM: very small Market Cap’ Velocity of circulation on the BRVM equity market is the lowest in Africa (1.8% in 2004 / 47% in the JSE) Hardly any bond trading, no real secondary bond market

11 OECD Development Centre Cost of Capital in the CFA Area: Mixed Outcome However, local financial systems remain extremely shallow –Illiquid financial markets USD million, end-2004Market Cap' Share trading JSE South Africa Namibian SE Cairo & Alexandria SEs Casablanca SE Ghana SE Nairobi SE Mauritius SE BRVM Lusaka SE

12 OECD Development Centre Cost of Capital in the CFA Area: Elements of Explanation Is the peg really credible? –On the face of it, yes it is (guarantee of the French Treasury, de facto currency board) –However recurrent rumours of devaluation: the 1994 devaluation has set a precedent –Is there an implicit currency premium? Apparently not…

13 OECD Development Centre Cost of Capital in the CFA Area: Elements of Explanation WAEMU & CAEMC sovereign still perceived as fragile obligors by foreign investors – Poor track record –Structurally flimsy public finances (limits of the HIPC initiative) and low ratings (Fitch & S&P’s) From CCC (Cameroon) to B+ at best (Senegal / Benin) No investment grade –High country risk in general (Ivory Coast as a case-in-point)

14 OECD Development Centre Cost of Capital in the CFA Area: Elements of Explanation Little developed corporate sector –Limited liquidity of debt instruments / preeminence of commercial loans –The very few bond issuances can be underwritten locally –Poor legal and business environment in the WAEMU and CAEMC: high jurisdiction premium requested by foreign investors –Poor corporate governance / Stringent listing requirements and expensive fees in the euro-zone for bond issues

15 OECD Development Centre Cost of Capital in the CFA Area: Conclusion The peg is potentially a useful instrument to reduce capital costs in the CFA franc zone Yet, the other components of the country risk premium tend to nullify the benefits of the peg ☞ The CFA peg is no "magic bullet" to deepen WAEMU and CAEMC financial systems and to reduce capital costs in the region