TOWARDS A FRAMEWORK FOR FINANCIAL INTEGRATION: LESSONS, ISSUES AND OPTIONS FOR NORTH AFRICA

1. TOWARDS A FRAMEWORK FOR FINANCIAL INTEGRATION: LESSONS, ISSUES AND OPTIONS FOR NORTH AFRICA Dr. Michael I. Mah’moud Lead Financial Economist African Development Bank Forum on Trade in North Africa Marrakech, February, 2007

2. Objectives of the Presentation • Review progress and obstacles towards financial integration in North Africa • Show the need for appropriate strategy/framework • Flag options and issues in the design of the framework • Discuss possible implications for trade

3. I. The African Monetary Cooperation Program • The African Monetary Cooperation Program involves adoption of measures progressively and in stages to culminate in the establishment of single African currency in 2021 • After establishment of Committee of Governors in Stage 1, Stages 2-4, the preparatory stages, seek to harmonize macroeconomic policies, promote convergence, and reduce imbalances • Stages 5&6, the transitional stages concern adoption of the exchange rate system and the necessary infrastructure towards establishment of the single currency and common central bank

4. I. The North African Monetary Cooperation Program Stage II (2004-2008) has 3 sets of criteria Primary Criteria • Overall budget deficit (excluding grants)/GDP< 10% . • Annual inflation rate < 9%. • Central Bank credit to finance budget deficit <10% of previous year’s tax revenue. • External reserves as months of imports ≥ 3 months.

5. I. The North African Monetary Cooperation Program Secondary Criteria • Elimination of debt arrears and non-accumulation of new arrears. • Maintenance of real exchange rate stability . • Maintenance of positive real interest rates. • National saving / GDP ≥ 15 %. • Public investment financed by domestic resources / tax revenue ≥ 20%. • External and domestic debt / GDP ≤ 100%. Other Criteria • Modernization and harmonization of payment systems. • Adoption of international standards on banking and financial supervision. • Liberalization of remaining exchange controls to promote capital movements. • Promotion of cooperation among all financial regulators in the sub-region

6. Progress and obstacles Good progress on monetary cooperation program • Budget criteria: met by all countries, except Egypt and Mauritania • Inflation: all countries, except Mauritania (12.5%) achieved <9% • Central bank financing of gov’t: not used in Algeria, Egypt, Libya, Tunisia and Mauritania (since 2004), but rose 11% in Sudan • External Reserves: Missed by Sudan and Mauritania; more than met in other countries • Qualitative measures in secondary and other criteria also being implemented – generally N. Africa does not suffer externally-generated imbalances as in other sub-regions Major challenge: limited progress on wider regional integration (eg. harmonization of trade regulations and interconnection of payments systems) to support progress on financial integration.

7. Single indicator/target versus Multi-indicator/target • Coordination involves choice of indicators and targets -- type and number already decided in context of the AMCP; • The type of indicators normally depend on the objectives and stage of coordination – convergence in macroeconomic environment, preparation towards irrevocably-fixed exchange rates; • Number of indicators – single or multi-indicators should depend on stage and purpose of coordination • Single indicators -- avoid over-coordination, give economic operators one clear signal of direction, but can weaken surveillance on other important variables • Multi-indicators – authorities pay attention to a set of important variables, and reduces chances of false signals

8. Rules versus Discretion • Coordination towards financial integration likely to involve issues in the setting of monetary policy instruments (int rates and exch rates); • Instrument setting source of long and continuing debate on rules vs discretion • Case for rules – reflects success in managing existing monetary unions; decreased need for frequent coordination; viable mechanism for imposing discipline on economic policymaking; helps predictability in policy direction and facilitates private sector response • Case for discretion – not yet monetary union; constrains adaptability to changes in economic environment, which can be significant in African environments (external shocks and structural rigidities)

9. Rigid versus Flexible Policy Coordination • Budgetary and monetary policy coordination normally useful in financial integration arrangements; • Undisciplined budgetary policies and wrong fine-tuning can have unfavourable national and international spillover effects; • However, domestic discipline – official or market-based normally weak, while external donor restraints based on conditionalities; • Community or peer group surveillance could be plausible but, in face of inter-country differences, absence of mechanisms for transfers or reserve pooling may make rigid rules problematic; • In transitional stages rules possible, but should rules be in form of ceilings or specified bands, hard or soft target zones?

10. Regular versus Periodic Reviews • Coordination enhanced by regular, ongoing reviews; • multi-period bargaining expands opportunities for policy bargaining and phasing, and may have total welfare effects exceeding that of single, once-for-all adjustment; • phasing enhances implementation, while agreements reached in rush or in response to crisis may not reflect all constraints (preset and prospective) of member countries; • Regular reviews would require surveillance mechanisms to monitor and appraise performance, and committees to encourage or enforce compliance – through moral suasion, incentives and/or sanctions; • Present arrangements do not give RECs or committees enforcement powers – no financial clout, cost/benefit considerations; • Coordination committees correctly involves central bank governors

11. Hegemonic versus Symmetric Arrangements • Direction of coordination may be dominated by one country or group (hegemonic) or influenced by all participating members (symmetric) • Symmetric system can enhance ownership and engender political acceptability • Hegemonic system may have attraction where an organized group already exists (not case in N. Africa) or association with another group desired • Conditions for successful hegemonic system include: (i) leader’s unblemished record for economic stability, (ii) leader’s dominance in trade and/or finance, and (iii) leader’s readiness to accept implied responsibilities • Member’s may consider extent of interdependence, and available financial support, • A blend arrangement, as in the cfa zone, also possible

12. Single track/speed versus Multi-track/speed • Some countries may have difficulties adopting the group pace because of economic or political constraints, but integrating programs cannot adopt pace of slowest moving members • Current AMCP considers inter-country differences by adopting program in 6 stages, with some stages being accommodatingly long; but it has implementation risks • Grouping for different speeds may reflect existence of optimum currency areas, but this also recalls need for political acceptance of complementary actions • N. Africa can fulfill conditions for optimum currency area provided complementary actions can be adopted

13. Exchange Rate Arrangement versus Full Monetary Union • Full monetary or financial integration has advantages: • price stability to improve efficiency in resource allocation reduced exch rate variability and transaction costs and increased credibility in policy direction can facilitate intra group investment flows • pooling of exchange reserves may generate saving in real resources to the extent that members are subject to unsynchronized fluctuations in BOPs, and creation of union does not lead to relaxation of monetary policy • But, full monetary union also has costs, mainly loss of sovereignty over monetary policy and loss of instrument in monetary policy formulation • Other options include forms of exchange rate unions – informal or formal

14. Financial Integration and Trade • Volatility in quantity and prices (exchange rates and interest rates) have adverse effects on the real sector • Excessive volatility can constrain ability of governments and private sector operators to enter into new binding commitments • It is difficult for developing countries to hedge large and prolonged nominal fluctuations • Financial integration reduces likelihood of protectionism • If accompanied by financial support, integration arrangements can provide cushions against shocks

15. Relevance of financial integration in North Africa • Financial integration useful in supporting wider economic integration • Integration most relevant in tackling region’s challenges, including • low share in world output; • Low investments/GDP ratio; • Low share in the intra-African and world trade; and • A fragile financial system. • North Africa can create a market of 130 million consumers for efficiency gains and attraction of foreign investments • Complementarity index estimated at 21%, while intra-regional trade = 45% of continental GDP and 40% of its trading activities • Longer term progress in financial integration requires establishment of institutional arrangements as in other sub-regions and the adoption of appropriate framework

16. End Thank you for your kind attention.