THE EFFECT OF CURRENT ACCOUNT IMBALANCE ON ECONOMIC

GROWTH: CASE OF WAEMU COUNTRIES.

GBODOSSOU FLORA DONSI DADO

Presentation Title: Analysis of a current account imbalance determinant in countries
with a currency pegged to euro: Case of WAEMU zone countries
Research focus: Factors that cause a constant Current Account imbalance of WAEMU countries

School: Liaoning University

Student Level: PhD

Abstract

The main purpose of this study is to evaluate the different factors that cause a constant Current
Account imbalance to the WAEMU countries. We will try to define the variable that have an
effect on that deficit in some countries and the surplus in other, and analyze at the same time the
potential reasons.

The relation between Current Account imbalance and the independent variables was tested using
the Ordinary Least Square (OLS) model. Our expectations were the pegged money plays an
important role in the Balance of Payments deficit in the WAEMU countries.

Key words: Current Account imbalance, deficit, surplus, Inflation, exchange rate, Gross
Domestic product, Money supply, interest rate, Foreign Direct Investment.
INTRODUCTION

The buying and selling of goods and services across national borders, known as international
trade is the backbone of our modern world. Countries with an open economy are increasing and
thus are creating relationships between international trading countries. Therefore, the increase or
decrease of goods and services of international trade have consequences in quite the worldwide
prices. Accordingly, prices of products such as mineral fuels, oil distillation products, with an
export amount of $2,183,079,941 or as electrical and electronic devices, $1,833,534,414, will be
determinant in many countries ‘world markets.

Africa is also taking part of that modern economy system. The continent is deepening African
integration, making trade facilitation, mainstreaming it.

International trade cannot be mentioned without referring to the Balance of Payments. The
balance of payments of a country is the difference between all money flowing into the country in
a particular period of time and the outflow of money to the rest of the world. These financial
transactions are made by individuals, firms and government bodies to compare receipts and
payments arising out of trade of goods and services.

The balance of payments has three components; the current account, the financial account, and
the capital account. The Current account measures international trade, net income on
investments, and direct payments. The financial account describes the change in international
ownership of assets. The capital account includes any other financial transactions that don't affect
the nation's economic output.

The current account also measures international transfers of capital. It represents a country's
imports and exports of goods and services, payments made to foreign investors, and transfers
such as foreign aid. It may be positive (a surplus) or negative (a deficit); positive means the
country is a net exporter and negative means it is a net importer of goods and services.

A country's current account balance, whether positive or negative, will be equal but opposite of
its capital account balance.

Exports from African countries are about US $ 10 036 701 296 Million and its imports of US $ 7
580 894 Million. Thereupon, Africa has a current account surplus.
However, that is not the case for each African country. The WAEMU trade balance has always
been in deficit since the independence in 1960.

The West African Economic and Monetary Union (WAEMU), founded in 1994, in response to
the devaluation of their common currency the FCFA, is composed by 8 countries, sharing the
same currency, and benefiting from common cultural traditions. Among those countries, just one
had a balance of payments (BOP) surplus (2019). The countries of the union are Senegal, Mali,
Benin, Ivory Coast, Burkina Faso, Niger, Togo, Guinea Bissau. The country with a BOP surplus
is Ivory Coast.

The main objective of the West African Economic and Monetary Union (UEMOA) is to achieve
economic integration in the sub-region, in order to ensure sustainable socio-economic
development of the community space.

Its specific objectives are to strengthen the competitiveness of the economic and financial
activities of the states; the creation of a common market, based on the free movement of people
of goods and services, capital and the right of establishment as well as on a common external
tariff and a common commercial policy; the convergence of states' performances and economic
policies, through the institution of a multilateral surveillance procedure; harmonization of the
laws of the member states to the extent necessary for the proper functioning of the common
market; and finally the coordination of national sectoral policies, through the implementation of
common actions and possibly common policies in the main areas of economic activity.

The WAEMU currency is pegged to Euro. A currency peg is a policy in which a national
government sets a specific fixed exchange rate for its currency with a foreign currency or a
basket of currencies.

Over the year 2019, the UEMOA countries imported more than they exported. However, there
was a slight increase in exports (+ 3.08% to 16,771.6 billion FCFA), which was accompanied by
a reduction in imports (-2.05% to 20,708.8 billion FCFA), generating thus an improvement of
19.21% to 3 937.2 billion FCFA of the trade deficit.

According to figures published by the BCEAO, the structure of exports has remained stable,
composed mainly of agricultural raw materials, products generally with low added value: gold
and precious metals (+ 10.98% to 4,118.9 billion FCFA), cocoa products (+ 10.81% to 2,811.6
billion FCFA), petroleum products (-3.41% to 1,337.6 billion FCFA) cotton products (-3.47% to
993.5 billion) cashew products (-19.24% to 742.3 billion FCFA) rubber (+ 14.98% to 482.8
billion FCFA), uranium (+ 18.77% to 139.2 billion FCFA) and coffee products (-3.61% to 80.2
billion FCFA).

The structure of imports was dominated by food products (+ 18.07% to CFAF 4754.6 billion),
capital goods (+ 7.04% to CFAF 4585.4 billion), intermediate goods (+7, 47% to 4119.2 billion
FCFA). We also note energy products (-17.56% to 3,573.5 billion FCFA) and consumer goods (-
44.73% to 1,636.5 billion), the main contributors to the decline.

The statistical data of foreign trade show its low participation in international trade. This
phenomenon is linked not only to the non-competitiveness, to the non-diversification of its
products for export, to the fluctuation of product prices and the dollar on the international
market, but also to its strong external dependence on supply. This explains the deficit in its trade
balance over this entire period. Foreign trade through the collection of customs duties and similar
taxes constitutes the main source of financing of the State budget.

In this study, we aim to understand different aspect of the current account imbalance in the
WAEMU countries, and point out the variables that have a relationship with it. We will study as
well the effect the current account imbalance has in the economy of those countries.

Problem statement

WAEMU countries experience current account deficit since the independence in 1960, expect
from Ivory Coast.

That situation affects the economy directly since we feel the consequences in the countries. One
of the first consequences is, because of the fact that most of what those countries consume comes
from abroad, the price level of most of the commodities is very high, and therefore, the
purchasing power of the household is lower.

The main reason of the persistent current account deficit could be the fact that the WAEMU
countries don’t invest enough in finished product but focus on the export of raw material, which
is not very profitable due to the low benefit margin from it.
Also, the WAEMU countries are pegged to euro, and as we know, an overly low currency peg
keeps domestic living standards low, hurts foreign businesses, and creates trade tensions with
other countries.

A current account deficit is not necessarily harmful. A current account deficit could occur during
a period of inward investment (surplus on financial account). This inward investment can create
jobs and investment. E.g. the US ran a current account deficit for a long time as it borrowed to
invest in its economy. This enabled higher growth and so it was able to pay its debts back and
countries had confidence in lending the US money. But the problem is that, most of WAEMU
countries borrowed without investing that money in creating job sectors.

Governments seeking economic growth like to invest in physical capital: new roads, beautiful
bridges, sparkling airports, stadiums and other infrastructure. In contrast, they tend to show much
less interest in investing in human capital, which can be defined as the total value of a
population's health, skills, knowledge, experience and habits. . In this, these governments are
making a mistake, because the disinterest in investing in human resources can drastically weaken
the competitiveness of a country in a rapidly changing world whose economies need more and
more skilled labor for maintain their growth.

In Senegal for instance, only 66% of fourth-grade teachers had mastered the language program
they were supposed to teach and only 68% had the minimum knowledge necessary to teach
mathematics. In the health sector, practitioners in that country could only correctly diagnose
common pathologies such as malaria, diarrhea, pneumonia, tuberculosis and diabetes in 53% of
cases.

Another aspect is that Africa's contribution to global value added increased from 1.2% to 1.1%
between 2000 and 2008 while that of Asia rose from 13% to 25% during the same period. Hence
there is a paradox between the level of industrialization and the availability of raw materials at
the continental level.

The Union must give considerable attention to industrialization. The land and the underground of
the countries of the Union are very rich and many Western countries devote themselves to its
exploitation and the transformation of its products using their advanced industries. Thus, the
transformation of our own products on the spot will make it possible to increase the economy of
our States, to lead the Union towards a considerable development and to allow us to measure
ourselves against the various economies on the planet.

As mentioned, Ivory is the only countries where current account surplus occurs.

In 2017, Ivory Coast trade balance remained in surplus, in line with its economic potential. The
trade surplus is estimated at CFAF 1,708 billion against CFA francs 1,316 billion in 2016. The
overall level of trade thus increased by 12.2%, from 11,493 billion CFA francs in 2016. To
12,896 billion CFA francs in 2017. Exports of goods, especially merchandise, increased by 14%
in 2017 compared to 2016, from 6,404 billion CFA francs to 7,302 billion CFA francs.

This performance, despite the drastic 40% drop in world cocoa prices during this period, can be
explained, according to him, mainly by a good performance of export products, in particular
cocoa, cashew nuts and cotton lint. The flow of exports from the Ivory Coast is divided between
Europe with 46.5%, Asia with 16.1%, Africa with 23.1% and America with 12.7%.

Imports also recorded an increase in value of 9.9% in 2017 compared to 2016 to reach CFAF
5,594 billion. They mainly concern crude oil, mechanical and electrical machinery, rice, fish,
pharmaceutical products mainly from China (13.5%), France (11%), Nigeria (9.2%) , Spain
(9.1%) and India (4.7%).

Objective of the research

General objective

The WAEMU countries have a consistent current account deficit. We strongly think that it has a
bad effect on the economies of those countries. In this research, we would first like to show the
relationship between those two variables prelisted and then underline the other variables that
might have a relationship with the current account deficit of the Union.

We would also like to underline the reasons of the current account surplus of the country of the
zone, and point out the reasons.
Specific Objectives

The specific objectives of our study are:

- To show the effect of current account deficit on the economy of WAEMU countries

- To show the effect of current account surplus on the economy of WAEMU countries

- To see if there are other determinants that has an effect on the current account imbalance

- To find solutions that might improve the current account deficit of the WAEMU countries we
can base our research on some other countries and make comparison.

Justification of the study

Current account deficit occurs in lots of countries in the globe. It might not have a bad effect on
the economy in some cases, but in others affect it in a real daily base.

The WAEMU has been created since 1994 as a response to the devaluation FCFA. But most of
the countries that belong to the union are poor countries and are having bad economy growth
performance. Those countries import an important part of their consumption and even their first
commodity products. The fact that almost everything is imported put a high margin on the final
price and therefore make it hardly affordable for most of people, knowing that the GDP per
capita of those area is very low.

At the end of the study we would like to be able to point out the different reason why the current
account is persistently deficit, how it affects the economy, but we would like also to underline
some solutions.

On the other hand, there is a WAEMU country which has a current account surplus, we would
like to underline the reason of and see in what extend the other countries could learn from it.
Literature review

There are many researches done on the relationship between current account deficit and
economic growth.

We will have a general view of the author first and then mention more specific work on that
relationship mainly in WAEMU countries.

As far as our work is concerned, we will underline the important aspects of other author study
which refer to ours.

Findings obtained in some studies examining the relation between current account deficit and
economic growth show that there is a strong relationship between two variables [Khan and
Knight (1983) and Howard (1989)]. Results showed that economic growth has effects on
current account deficit. The current account balance of the balance of payments in various
countries has often presented a deficit situation reflecting many short-term and long-term
macroeconomic imbalances, including the trade imbalance (between imports and exports), the
financial imbalance (between Investments and savings) and the change in transfers (net
transfers). Thus, the current account is a macroeconomic indicator that provides short-term
information, both on domestic and international economic conditions, and in the long term
reflects the country’s competitiveness (Gnaro, 2004). Indeed, a one-time deficit in the current
account can be attributed to an unpredictable shock, but when it persists, it leads to an increase in
external debt (Ben Abdallah, 2000). Devarajan and Rodrik (1991) show that the countries of the
CFA Franc area, because of the parity of their currency with the French Franc (now the EURO),
suffer from the external shocks inherent in their terms of trade and whose costs are high. They
find that countries in the CFA zone have tried to keep inflation rates low in contrast to non-CFA
countries. According to the authors, the difference between the two rates is 14 points. However,
they point out that the production costs to maintain a fixed exchange rate surpass the profit
associated with a low inflation rate. Overall, the authors conclude that, in general, the fixed
exchange rate was a poor arrangement for countries in the CFA zone. Based on a study of a
sample of 35 SSA countries over the period 1985-2009, Coulibaly and Davis (2013) have almost
reached the same conclusion that countries in the CFA zone benefited in terms of inflation
without resulting in a significant effect on economic growth. Economists often look at the
relationship between the current account deficit and the fiscal deficit (twin deficits) using the
accounting identity for the Gross Domestic Product (GDP) rated Y.

Given that Y = C + I + G + X - M, on the one hand, and Y = C + S + T, on the other hand, with

C = consumption; I = investment; G = government spending; X = exports; M = imports; S =

saving and T = taxes, and by equalizing the two equations we have:

(S - I) + (T - G) = (X - M) or private saving + public saving = current account balance.

Since the current account balance is equal to net exports, we can conclude that a current account
deficit is the excess of investment over saving plus the excess of government spending over tax
revenue. To reduce the current account deficit, many economists conclude that the surplus of
investment must be reduced on savings or budget deficits. If investment keeps a nation’s capital
stock, the focus is on increasing savings and reducing the budget deficit. To this end, Obstfeld
and Rogoff (1995) consider that it is necessary to specify the determinants of private investment
and saving behavior while emphasizing the inter-temporal nature of these behaviors. For
example, when consumers seek to improve their consumption, they prefer to go into debt. The
result is a reduction in savings and, consequently, a deterioration in the current account balance.
The temporary decline or the anticipated decline in income leads to a decrease in the surplus or
an accumulation of the current account deficit (Rouabah, 2005).Frankel and Razin (1987), using
a general equilibrium model, analyze the effect of fiscal policies on current account behavior.
The results show that, depending on whether a country has a current account deficit or surplus,
the effects of fiscal policy will be different. Similarly, Blanchard (1983) develops a current
account model that integrates the costs of investment facilities. The results show that an
economy of the size of Brazil will need a steady 10% trade surplus to meet an external debt of
about 300% of GDP. Also, Obstfeld and Rogoff (1996) show in a model adapted to a small open
economy that for a debt-to-GDP ratio of 15, the trade surplus needed to repay debts is around
45% of GDP. Cordoba and Kohoe (2000), on the basis of a calibration model of the Spanish
economy, conclude that the optimal response to financial reform is to allow the current account
deficit to rise, to 60% of GDP.

Erbaykal(2007) carried out a causality test using Toda and Yamamoto analysis, in which he
identified causality both from economic growth and from exchange rate to current account
deficit. Aristovnik (2006) examines the main determinants of the current account balance to
assess the possible extension of current account deficits in selected transition economies, Eastern
Europe and the former Soviet Union. The analysis covers the period 1992-2003 and using
different estimates for both empirical models (A and B) the author find: Economic growth has
negative effect on the current account balance, implying that the increase of growth rate is
associated with higher rise of investments than savings; Confirm the hypothesis of stages of
development, as the poorer countries in the region register higher deficits in the current account;
Fiscal balance has positive and significant impact on the current account, confirming the validity
of the hypothesis of a double deficit; The appreciation of the real exchange rate and the
deterioration of terms of trade (TOT) aggravate the current account deficit the current account
deficits in transition economies. Sadiku (2015) in his study found out that there is a relationship
between current account deficit and current account balance, budget balance, economic growth,
net foreign investment, financial development, terms of trade, openness, oil prices, foreign direct
investment.

Das (2016) considered international commodity prices as one of the current account determinants
and found the existence of a negative relationship between the current account and commodity
prices for developing economies. He used panel GMM techniques to evaluate the current account
determinants for a sample of 106 countries. The study found the existence of a positive
relationship between commodity prices, real GDP growth and trade openness in emerging
economies, and a negative relationship between the same variables and the current account for
the developing nations.

In addition, Kariuki (2009) examined the determinants of the current account balance in Kenya
using the intertemporal approach for the period 1970 to 2006. The study includes economic
growth, the fiscal balance, terms of trade, trade openness, money supply, dependency ratio,
foreign direct investment and macroeconomic stability. The study also included a crisis dummy
variable in order to capture effects of external shocks such as the oil crisis of 1973,
mismanagement of the coffee boom in 1976/77 and the collapse of the East African Community.
The model, based on time series analysis, showed that the terms of trade was the most significant
positive determinant of the current account deficit in Kenya. Other positive determinants
included the fiscal balance, real exchange rate and economic growth. Money supply, on the other
hand, was the most significant negative determinant of the current account balance in Kenya,
followed by the dependency ratio and foreign direct investment.

EMPIRICAL ANALYSIS

The first aim of our study is to check whether there is relationship between current account
deficit of the WAEMU countries and the economic growth if that same area ; if it is the case,
know in which extend they are correlated.

Another objective of this paper is to figure out other variables that can affect current account
balance, of union. And the other variables we will be using are budget balance, economic
growth, net foreign investment, financial development, terms of trade, openness, oil prices,
foreign direct investment.

Data Sample

Our data are from 1960 to 2018 in a concern to have enough observations to run our regression.

The majority of our data are from the World Bank and the National Agency of Statistics and
Demography of Senegal.

Proposed empirical results and analysis

As mentioned, our paper is about the relationship between current account deficit in WAEMU
countries and the economic growth of the same area. We would also like to check the
relationship between current account deficit and other possible variables. We will therefore make
the same tests on all the 8 countries which are in the union (Senegal, Mali, Benin, Ivory Coast,
Burkina Faso, Niger, Togo, Guinea Bissau); using then a panel data.

We also would like to test the causality between Current account deficit and economic growth

To reach our goal, many tests will be used:

 1) Ordinary Least Square Method
The method of least squares determines a line of best fit for a set of data points. It finds
the line by minimizing the sum of the squared residuals (that is, the distance from each
data point to the line), hence the name, least of the squares. There are methods for finding
parabola and polynomial least squares, although the most common form is Ordinary
Least Square, which finds a straight line of best fit.

Ordinary Least Squares is the standard linear regression procedure. One estimates a parameter
from data and applying the linear model

y = aX + b

Where y is the dependent variable or vector, X is a matrix of independent variables, b is a vector

of parameters to be estimated, and b is a vector of errors with mean zero that make the equations
equal.

Our proposed regression model is

Y=β0+β1X+ϵ

CAI =C0 - C1E gr + C2 BB gr C3ER gr + C4NFA + C5FD gr + C6TOT + C7O+ C8OP+ C5FDI
gr+ εt (1)

CAI= Current Account Imbalance

C0= intercept

E=economic growth,

BB=budget balance,

NFA=net foreign investment,

FD=financial development,

TOT=terms of trade,

O=openness,
OP=oil prices,

FDI=foreign direct investment.

2) Granger causality test

In this study, we would to test the causality effect of Current account deficit and economic
growth.

Granger causality is a statistical concept of causality that is based on prediction. According to

Granger causality, if a signal X1 "Granger-causes" (or "G-causes") a signal X2, then past values
of X1 should contain information that helps predict X2 above and beyond the information
contained in past values of X2 alone. Its mathematical formulation is based on linear regression
modeling of stochastic processes (Granger 1969).

G-causality is normally tested in the context of linear regression models. For illustration,
consider a bivariate linear autoregressive model of two variables X1 and X2:

X1(t)=∑j=1pA11,jX1(t−j)+∑j=1pA12,jX2(t−j)+E1(t)X2(t)=∑j=1pA21,jX1(t−j)
+∑j=1pA22,jX2(t−j)+E2(t)(1)

Other methods might be used as we go further in our research.

Expected outcome

In this study, we are looking for to pointing out the relationship between current account deficit
and economic growth of the WAEMU countries.

We hope that we can detect the reasons of that constant deficit and give good suggestions to
better off the economic growth of those countries.

In addition, we want to find out other variables that cause the current account deficit in Senegal
as well.
TABLE OF CONTENTS

ACKNOWLEDGES

ABSTRACT

INTRODUCTION

PART I THEORITICAL ANAYSIS

CHAPTER I: GENERAL FRAMEWORK

1.1 Problem statement

1.2 Aim of the study

1.3 Justification of the study

CHAPTER II: LITERATURE REVIEW

CHAPTER III: AN OVERVIEW OF SOME AFRICAN COUNTRIES WITH A

CURRENT ACCOUNT SURPLUS

3.1 Economic history

3.2 Current situation of the current account

3.3 Government policy to help economic growth

3.4 Relationship between current account balance and economic growth in those countries

3.5 Other variables that have an effect on the current account balance in those countries

CHAPTER IV: AN OVERVIEW OF SOME AFRICAN COUNTRIES WITH A

CURRENT ACCOUNT DEFICIT

3.1 Economic history

3.2 Current situation of the current account

3.3 Government policy to help economic growth

3.4 Relationship between current account balance and economic growth in those countries

3.5 Other variables that have an effect on the current account balance in those countries

CHAPTER V: CURRENT ACCOUNT IN WAEMU COUNTRIES

4.1 Evolution of the CA in WAEMU countries

4.2 Economic relationship between countries

4.3 Relationship between CA and Economic growth in WAEMU countries

4.4 Empirical studies

4.5 Results and conclusion

PART II: EMPIRICAL ANALYSIS

CHAPTER VI: EMPIRICAL STUDY

6.1 Model specification

6.2 Data sample

CHAPTER VII

7.1 Empirical Results and Analysis

7.2 Comparison of the results between countries with Current Account deficit and the one with
current account surplus

7.3 Interpretation of results of WAEMU countries

PART III: RESULTS AND SUGGESTIONS

CHAPTER VIII: CONCLUSION AND RECOMMANDATIONS

APPENDICES

REFERENCES
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