The ECOWAS countries are divided into two groups, i.e., the CFA franc zone and the WAMZ (West African Monetary Zone). The CFA franc zone countries adopt the euro-peg regime and the pooled foreign reserve system financially supported by the French Treasury during over 60 years. On the other hand, the WAMZ countries adopt the managed floating regime to introduce their common currency in 2014. Accordingly, this paper can investigate one of the important benefits of zone membership, that is, the lack of foreign exchange constraints by comparing the empirical results between these two groups in West Africa.
This paper improves on the technology of Moran (1989, WBER) and Emran and Shilpi (2008, RIE), and applies it to the ECOWAS member countries, by explicitly considering an intertemporal optimizing model. An important departure of this paper is to test the foreign exchange constraint under the permanent income hypothesis by including permanent income as an explanatory variable in the estimated import demand function.
To check the long-run relationship between import demand and foreign reserves, this paper does the cointegration test following the ARDL (Autoregressive distributed lag) bounds testing approach by Pesaran et al. (2001, J of applied Econometrics) . The results show that the foreign reserves were not statistically significant in determining import demand for the CFA franc zone, but significant for the WAMZ. Moreover, the application of Bai and Perron (1998, Econometrica) test to these import demand functions shows that these results are robust even if we consider the structural changes occurring at unknown dates.
These results indicate that the currency convertibility guaranteed by the French Treasury enables a more efficient intertemporal allocation of consumption for the CFA franc zone countries. The convertibility is thus a benefit of zone membership, allowing imports to be determined optimally. On the other hand, the future monetary zone, WAMZ, cannot get this benefit at this stage. Accordingly, it seems to be better for the WAMZ authority to consider the guaranteed system of the currency convertibility as one of the efficient monetary tool in choosing the anchor currency of their future common currency.
However, the current system of currency convertibility may not be sustainable for the following two reasons. First, the pooled reserve system produces inequality among member countries, because the constant foreign reserve shortage of some countries has been financed within the offset account. Second, the recent trend of greater discipline on the Treasury of anchor country makes it more difficult to bear the operation cost of this system. Although the lack of foreign exchange constraints may be a benefit of the system, these problems may become a limiting factor in its operation for the ECOWAS countries.