Misalignment of the real exchange rate in the African Financial Community (CFA zone) and its policy implications

The purpose of this study is to see whether the same pre-devaluation overvaluation (1980 to 1993) of the Communaute Financiere Africaine (CFA) franc exists for the post-devaluation period (1995 to 2004). As overvaluation can have significant negative impacts on exports, it is imperative to investigate whether this has continued. First, we found that the same overvaluation exists for the post-devaluation period. Second, we observe that post-devaluation, the overvaluation trend has been reverting and recurring downwards until 1999 and 2000 and steadily increasing since 2001. In fact, the average overvaluation for the zone is estimated at 25% in 2004 which is about 85% of the pre-devaluation level. Third, the economies where agriculture dominates are more overvalued than the economies where agriculture does not dominate. This stylized fact is similar to pre-devaluation observations by Devarajan (1997). Fourth, we also found that the oil producing countries are less overvalued than the nonoil producing countries; and the middle income economies are less overvalued than lower income economies. The latter two stylized facts are contrary to the pre-devaluation dynamics observed by Devarajan (1997). Finally, the empirical analysis suggests that the anticipated contribution of the parity relationship to the overvaluation of the currency is minimal. Instead, the macroeconomic variables that have the most negative influences on the Real Exchange Rate (RER) of the CFA franc are terms of trade shocks, increases in investment and aid inflow.