Below is a short report first written by Ecobank.
Growing anti-euro political sentiment in the EU is increasing risks to the outlook of both CFA francs (CFAF), XOF and XAF, which have been pegged to the euro at a rate of CFAF 655.96 = EUR 1 effective 1 January, 1999 (Chart 1).
Under the current arrangement, the French Treasury guarantees the free convertibility at a fixed parity between the euro and the CFAF and, any change to the nature or scope of the agreement would require Council approval on the basis of a Commission recommendation and ECB consultation.
The rise in populism across the EU has increased volatility in the EUR and hence XOF/XAF, and this trend is likely to worsen ahead of leadership elections in key EU states-France, Germany and The Netherlands this year.
Most notably, the leader of France’s far-right National Front party, Marine Le Pen, has been running a campaign
emphasising plans to pull France out of the eurozone and the EU. Le Pen has pledged to hold referenda on eurozone and EU membership within six months of coming to power, if elected.
Although recent French polls point to a 40% chance of a victory for Le Pen at the upcoming presidential election, scheduled for April-May, we cannot discount the possibility of another surprise victory at the polls as was the case in the UK’s Brexit referendum last year.
Given Le Pen’s campaign pledges, a potential win for her would fuel further problems for the EUR, which is already fundamentally weak amid economic challenges associated with eurozone’s fiscal and debt burdens.
Such an outcome would result in higher EUR volatility, and significant EUR weakening, which would be mirrored in the CFAF.
Bond yields will also increase as investors price in a high risk of France de-linking from the eurozone (an outcome that will see a devaluation of the French franc and a potential rise in inflation). Already, yields on France’s 10-year bonds have increased significantly (Chart 2), while the French-German bond spread is close to a four-year high.
In the event that France votes to leave the eurozone, this would somewhat mark the beginning of the end of EU’s political project.
An immediate scenario would see the EUR weaken sharply as capital exits the eurozone, while volatility will rise further.
France could potentially revert to adopting the French franc, increasing pressure by some CFA franc member countries to devalue or even de-peg from the newly-adopted French currency. The latter would involve a number of legal steps that would need to be ratified.
If CFA franc member countries agree to de-link/devalue, it will accelerate imbalances in the region in the short term (higher inflation, twin deficits, higher import costs and further currency weakness), specifically on key markets such as Cameroon, Senegal, Cote d’Ivoire, Chad, Niger, Mali and Togo, etc. Such markets will experience increased balance of payments pressures, especially as most of them are heavily dependent on imports from outside the CFA franc zone and the eurozone; already, over 30% of their imports are sourced from China, US, Nigeria, India and South Korea.
Whatever the outcome of the leadership election in France or other EU states, we believe that populism in Europe will continue to grow, sustaining uncertainties over the policy stance to be decided for the CFA franc zone.