By Henri Kouam and Dr. Fabien Sunjo (Download pdf version)
Exchange Rate Policy Reform to Boost Trade Between Cameroon and Nigeria
Exchange rate policies are necessary for a two-way trade as well as economic development between Cameroon and Nigeria. This policy brief looks at the impacts of invoicing international trade in dollars instead of the CFA Franc and Nigerian Naira. Invoicing global trade in the U.S. dollar increases the risks of banking and liquidity crisis while causing the currency to appreciate or depreciate erratically. This paper recommends that trade between Cameroon and Nigeria be invoiced in their own currencies and that incentives from institutions and policymakers increase the financial resilience of both economies and encourage two-way trade.
The exchange rate policy of a country is important as it determines the country’s trade performance, its current account balance, its external position, and the attractiveness of its exports. The exchange rate is determined by a country’s trade policy, and its relative valuation to other currencies has an impact on international trade, its balance of payments, and its overall economic performance.
The Communauté Financière Africaine countries belong to a monetary cooperation agreement with France, where the CFA franc is pegged to the French currency. Additionally, the whole zone pools its foreign exchange reserves together with an operational account at the French Treasury (Hadjimichael and Galy,1997). This guarantees the convertibility of the CFA franc. Furthermore, Cameroon’s economy is the largest, and all CEMAC member countries have a common exchange control system (World Bank, 2021).
However, when countries buy goods and services from each other, they do not pay in their own currencies but rather in foreign currencies such as the U.S. dollar, Euro, and Chinese Renminbi. Aguair et al. (2015) find that the majority of global trade is invoiced in U.S. dollars, the Euro, and the Chinese Renminbi. This is driven by the fact that developing economies rely on foreign currency borrowing, with the U.S. dollar accounting for 92% of all loans (Brauning and Ivshina 2015).
This pattern of invoicing Cameroon-Nigeria trade in foreign currencies does not support monetary stability, much less openness and convertibility of their domestic exchange rates. For example, Cook and Patel (2020) find that a stronger dollar and a contraction in U.S. credit causes trade in goods between countries to decline more than trade with the U.S.
Over time, trade patterns have changed, but invoicing in global trade is still dominated by foreign currencies. This policy brief looks at invoicing patterns for Cameroon – Nigeria trade, implications for the local economy, and concludes with policy proposals to reduce the economic and financial costs from invoicing in foreign currencies.
This policy brief is divided into five parts. Part 1 looks at the exchange rate policies and macroeconomic issues. Part two investigates the impact of an overvalued currency. Part three looks at trade between Cameroon and Nigeria and the impact of invoicing trade on the dollar. In part four, we analyze exchange rate movements, and trade flows between Cameroon and Nigeria. Part five comprises actionable policy recommendations followed by a brief conclusion.
Exchange Rate Policy and Macroeconomic Policy Issue
Besides protectionism, export taxes, and subsidies, a country can use its exchange rate policy to change the level of domestic production and industrialization as well as exports. According to Guzman et al. (2018), a stable and competitive exchange rate policy may promote economic development, and the regulation of capital flows is an essential element of exchange rate policies. The exchange rate policy is the central tool of trade policy with far-reaching effects since the expansion of exports is effectively linked to export and its relationship with domestic prices and costs. However, it is not easy to maintain a favorable real exchange rate since it also involves the macro-level management of the economy.
Short-run movements in the exchange rate today are largely related to changes in capital flows. These cyclical changes in capital flows have far more reaching effects than just the change in exchange rates, domestic prices, and trade flows. In the absence of fully countervailing measures by monetary authorities, they affect the flows of funds to different sectors of the economy, and thus, affect the structure of the economy. For example, Cameroon enacted a law to restrict the repatriation of operating revenue, and article 64 of the F.X. regulation from 2000 states that exports of goods or services above 5 million CFAF must equally be declared to the competent authority (MINFI 2021 and Droit d’Afrique 2000). As such, the effects of the change in the exchange rate on the economy may depend on the total policy package, but invoicing patterns have long-term implications for international trade, financial stability, the impact of economic shocks, and the likelihood of currency-induced banking crisis.
The measures taken by Cameroonian authorities will reduce the impact of external shocks on the exchange rate and equally cushion the shock from sudden changes in the price of commodities or the value of the U.S. dollar. Additionally, a stable currency will enable both Cameroonians and Nigerians to benefit from free trade and lower tariffs rather than bear the burden of excessively high trading costs.
Impact of an Overvalued Currency
A country’s exports are more competitive when its currency is weak, and the reverse tends to happen when a currency appreciates as its exports become expensive, causing external demand for its goods and services to fall. This causes their current account balance to shrink, the terms of trade equally deteriorate, and the economy grows at a slower pace. An overvalued real exchange rate partly explains the decline in agricultural exports in Cameroon after the trade liberalization reforms of the 1980s, which had an overwhelmingly negative impact on Cameroon’s terms of trade and external position.
Similarly, overvalued currency hurts domestic competitiveness, reduces the cost of imports, and makes exports more expensive for foreign countries. This has a negative impact on the country’s terms of trade and external position. As a result of this, Cameroon should seek to mitigate the adverse impact of invoicing its international trade in dollars as this will boost financial stability and prevent currency crises caused by a stronger dollar.
Cameroon – Nigeria Trade and Invoicing in Foreign Currency
Sub-Saharan Africa, including Cameroon, still stands out as a region for which there is relatively limited information and country coverage. Customs authorities do not collect invoicing currency data or do not collect it with sufficient accuracy (Douanes (2021))
Reserve data and dollar-denominated liabilities point to the fact that Cameroon invoices heavily in foreign currencies such as the dollar. Although the dollar remains the globally dominant currency in buying and selling goods across countries, the Euro may be regarded as a regionally dominant currency in Europe and some parts of Africa. Despite the fact that the U.S. dollar is the dominating global currency in trade invoicing, the Euro may be considered a regionally dominant currency in Europe and portions of Africa.
The Euro equally plays a leading role as a vehicle currency in many African countries due to historical and trade linkages (Boz et al., 2020). Gopinath et al. (2020) find that several African countries use the Euro for invoicing due to their historical and economic ties to Europe. Another reason for this is the fact that currencies such as the CFA are pegged to the Euro, and the European Commission’s decision to internationalize the role of the Euro is equally increasing the percentage of trade that is cleared in euros (Kouam (2021) and Wolff. (2020).
As a result, Cameroon-Nigeria trade is cleared in euros and U.S. dollar, which causes trade frictions, heightens financial stability risks, and widens trade imbalances. When the currency depreciates due to a sudden appreciation in the dollar, this does not boost trade between African countries but rather increases the likelihood of currency and banking crises. In recent years, however, the Chinese Renminbi may have started to play an increasingly important role as a vehicle currency in many African countries against the background of the region’s fast-growing trade with China (Kingsly and Kouam 2020 and CARI 2021).
However, exchange rate volatility does not affect trade except in the case of currency unions. Gopinath et al. (2015) and Bruno, Kim, and Shin (2018) point to the stickiness of trade invoicing channels, which tends to have a more lasting effect on economies.
As a result of this, a USD/CFA depreciation will not immediately disrupt Cameroon – Nigeria trade flows but can have significant effects on the export of crude oil and other goods or services that are priced in dollars.
Furthermore, prices of exports and imports tend to be sticky, which means that a depreciation in the dollar will not be immediately felt, while depreciation in the CFA Franc is reflected in global invoicing at a faster pace. This occurs because the dominant foreign currency reflects sudden depreciation in the exchange rate of the host country. At the same time, external factors such as changes in the price of global commodities, debt sustainability concerns, and economic indicators impact the value of the exchange rate. As such, the “invoicing channel” exacerbates the negative spillovers from external shocks and does not immediately reflect positive changes in the exchange rate.
Trade flows and exchange rate movement between Cameroon and Nigeria
A free-floating exchange rate that is pegged to the Euro has supported trade between Cameroon and Nigeria. When the currency depreciates, its exports become more competitive and vice versa. The set of market liberalization reforms that began in 1980 was effective at reducing trade barriers and boosting trade flows between Cameroon and Nigeria. However, trade flows have not grown steadily due to a mix of structural and external factors. However, the currency has always played an important role in trade but remains linked to oil prices and the value of the dollar.
As such, while domestic factors such as export bans and trade openness determine the volume of Cameroon – Nigeria trade, the currency which traders use to buy or sell goods and services equally has an impact on currency and financial stability.
Policy Recommendations and conclusion
In order to improve future commercial openness between Cameroon and Nigeria, we recommend the following:
- Policy makers should improve on already defined economic policies designed to improve exchange rate stability and reduce exchange rate The new F.X. regulation should be enforced in other to reduce exchange rate volatility and slow capital outflows when Cameroon experiences macroeconomic shocks. This will lessen the economic shocks that impact Cameroon – Nigeria trade.
- Secondly, financial incentives will enable the private sector to begin invoicing trade in domestic currencies. For example, the structure of liabilities should be included in the central bank assessment of banks that can access and use its liquidity mechanisms. The central banks’ mandate does not preclude it from enforcing macroeconomic stability, and an additional requirement will create an incentive for banks to finance traders and invoice trade in the Franc CFA.
- Finally, domestic payments systems in Cameroon should equally begin accepting payments in African currencies such as the Nigerian Naira. This will reduce the share of dollar liabilities in the financial system and boos financial stability over the long run. Furthermore, such an outcome will reduce exchange rate volatility and create buffers against external shocks on Cameroon – Nigeria trade flows.
Cameroon – Nigeria is driven by a mix of economic and financial policies in both countries. When Cameroonian traders import from or export to Nigeria, paying for such goods in U.S. dollars, euros or Renminbi has a negative impact on the Cameroonian economy over the long run. It increases the risk of a currency-driven banking crisis and causes the financial system to become dependent on foreign currencies through borrowing in foreign currencies.
By invoicing trade in the CFAF and Naira, Cameroon and Nigeria can increase the financial resilience of their economies and reduce the negative impact of unexpected appreciations in invoicing currencies.
- Aguiar, Mark, Manuel Amador, Emmanuel Farhi, and Gita Gopinath. 2015. “Coordination and Crisis in Monetary Unions.” Quarterly Journal of Economics 130 (4): 1727-1779. Publisher’s Version: coordination_and_crisis_in_monetary_unions.pdf
- Boz. E., Casas. C., Georgiadis. G., Gopinath. G., Le Mezo. H., Mehl. A., and Nguyen. T. (2020). Patterns in Invoicing Currency in Global Trade. IMF Working Paper, No 26/126
- (2021). China-Africa Trade. John Hopkins School of Advanced International Studies, China Africa Research Initiative.
- D. and Patel. N. (2020). Dollar invoicing, global value chains, and the business cycle dynamics of international trade. BIS Working Paper, No. 860.
- Droit D’Afrique. (2000). Réglementation des changes, Règlement n°02/00/CEMAC/UMAC/CM du 29 avril 2000.
- Falk Bräuning & Victoria Ivashina, 2020. “Monetary Policy and Global Banking,” Journal of Finance, American Finance Association, vol. 75(6), pages 3055-3095,
- M. T. & Galy. M. (1997). The CFA Franc Zone and the EMU. Working paper, 97/156. International Monetary Fund, African Department
- Kingsly and Kouam (2020). China Sneezes and CEMAC catches a Cold. SSRN Electronic Journal. DOI: http://dx.doi.org/10.2139/ssrn.3557298
- H. (2021). Here’s why we Should Care About What Happens to the Euro. On Policy Magazine,
- (2021). Exchange regulation in Cameroon. Ministry of Finance, Cameroon.
- G. B. (2020). Strengthening the international role of the Euro: Testimony before the European Parliament on the International Role of the Euro.Parlaimentary testimony, Brugel
- World Bank. (2021). The World Bank in Cameroon. World Bank, Washington DC.