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Financing Costs and the CFA Franc: a Promise yet to be Fulfilled Nicolas Pinaud

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. Cost of Capital in the CFA Area: Expected Benefits.

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Financing Costs and the CFA Franc: a Promise yet to be Fulfilled Nicolas Pinaud

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

  2. 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. 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. Cost of Capital in the CFA Area: Expected Benefits Zero CFA / Euro Currency Premium • 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

  5. 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. 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. 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. 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. 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. 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. Cost of Capital in the CFA Area: Mixed Outcome • However, local financial systems remain extremely shallow • Illiquid financial markets

  12. 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. 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. 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. 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

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