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16 Real Exchange Rate Misalignment in Cameroon, 1970–1996 Francis M. Baye and Sunday A. Khan Introduction Structural adjustment programmes sponsored by the IMF/World Bank were adopted by many African (SSA) countries in the 1980s. The main objective of these programmes was to revamp the incentive base of these economies with a view to increasing especially agricultural production and export – agriculture being the largest production and employment sector in these economies, and equally an important foreign exchange earner. In the adjustment programmes, exchange rate reforms took centre stage. This is because there is general agreement that the exchange rate plays a crucial role in the stabilization and adjustment process (Aghevli and Montiel 1991; Edwards 1990; Elbadawi 1992). In most African countries, therefore, the exchange rate has become a considerable policy instrument. This is particularly important to most of these countries because they produce and export primary products and need to be competitive on the international market. African Franc Zone countries, however, do not have the opportunity to unilaterally change the nominal exchange rate for economic policy objectives. Their currency (the CFA Franc) is institutionally pegged to the French Franc (FF) and through the FF to the Euro. The nominal exchange rate is therefore exogenous to them and does not constitute a policy instrument to an individual member. The change in parity between the FF and the CFAF can occur only by unanimous agreement of member countries and France. Being a member of the Franc Zone, Cameroon cannot use its nominal exchange rate (NER) as a policy instrument. But changes in the NER would affect the RER. It should be noted, however, that what influences international competitiveness is the real exchange rate and not the nominal exchange rate. The real exchange rate is an expression of the total macroeconomic environment and is a critical variable for developing countries to monitor and manage properly through fiscal, income and other policies if they are to avoid distorting relative production incentives between tradable and non-tradable goods (Bautista and Val- 329 Baye and Khan: Real Exchange Rate Misalignment in Cameroon, 1970-1996 dés 1993). In particular, the real exchange rate is the nerve centre of the economy, which transmits the effects of domestic macroeconomic policies and external factors to the tradable goods sector. A departure of the real exchange rate from its equilibrium path is believed to negatively affect the incentive structure of the production base of the economy. The issue now is whether Cameroon can influence its real exchange rate given that it cannot use its nominal exchange rate as a policy option. The main objective of this chapter is therefore to provide an empirical basis for the analysis of real exchange rate misalignment in Cameroon. This is decomposed into three specific objectives, which are to: (i) specify and estimate a real exchange rate equation for Cameroon, (ii) simulate the path of equilibrium real exchange rate (ERER), and (iii) compute the degree of real exchange rate misalignment. These objectives are motivated by the view that although Cameroon does not use its nominal exchange rate as a policy option, it can still influence its real exchange via other macroeconomic variables. The remainder of the chapter is in five sections, which in turn discuss the exchange rate arrangements in the Franc Zone, present a literature review on the real exchange rate, outline the methodology of the study, report the results and submit concluding remarks. Exchange Rate Arrangements in the Franc Zone Cameroon is a member of the Franc Zone (FZ) whose currency, the CFA Franc, has been pegged to the French Franc since 1948. This zone is made of two regional Central Banks, the BEAC and BCEAO.1 Member countries maintained a fixed parity between the CFA Franc and the French Franc (FF) of CFAF50 to the FF until 12 January 1994 when this was devalued to CFAF100 to the FF following a unanimous decision of the FZ member countries and France. Apart from the fixed parity between the two currencies, this zone is governed by a number of principles (M’Bet and Niamkey 1993), including free transferability of currency among members of the BEAC or BCEAO zones (transfer between zones was restricted in 1993). The reserves of the zone are pooled together and members use a common foreign exchange policy against the rest of the world. There is equally full convertibility of the CFAF to the FF through the Compte d’Operation kept at the French Treasury in which at least two...

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