The Case for CBDCs in Africa - A New Frontier for Economic Integration
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The Case for CBDCs in Africa - A New Frontier for Economic Integration
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By Tito John Mbathi
February, 2024
In the complex mosaic of global trade, it is rare to encounter a technology which maintains mindshare across several years. Distributed Ledgers are one such technology, transcending geographies and institutions. Today, it is led by the increasing focus on Central Bank Digital Currencies (CBDCs). Several pilot programs have been launched to assess the viability of CBDCs for international trade, with economies of the Global South driving the momentum.
In this setting, Africa stands at an intriguing juncture, where trade is the topic du jour and many central banks in the continent are actively pursuing CBDCs. These digital iterations of state-backed money find a unique resonance on the continent, where they can be more than a simple tech upgrade and instead act as a potentially transformative force that can reshape a fragmented economic system to usher in a new era of regional collaboration.
Rethinking Intra-African Trade
The African Continental Free Trade Area (AfCFTA) marks a pivotal step towards economic integration in Africa, aiming to leverage trade for the continent’s development. Despite the promise of a unified market, the AfCFTA's potential is yet to be fully realized. In 2022, intra-African trade constituted only 13.8% of the continent's total trade volume, a notable decline from the previous year. A key obstacle is the reliance on foreign settlement platforms, such as SWIFT, or currencies, such as the USD, which can be both costly and inefficient. And so, while the AfCFTA is laudable, efforts to localize settlement will be necessary to unlock its benefits.
Recognizing the importance of eradicating these financial obstructions to trade, the Afreximbank launched the Pan-African Payment and Settlement System (PAPSS) as a key component of the AfCFTA. PAPSS is a centralized settlement system designed to facilitate rapid cross-border payments in African currencies. PAPSS is revolutionary in its approach as it directly addresses the fragmentation of African financial markets by providing a platform that supports a multitude of African currencies. This not only streamlines the transaction process but also enhances liquidity within the continent, as funds no longer need to be routed through external intermediaries.
While this endeavor should be extolled, it still ignores many of the inherent shortcomings of traditional settlement rails, such as the existence of a single point of failure, counterparty risk, and limited interoperability. Moreover, the lack of trust in African currencies and financial institutions by Africans themselves will be a formidable challenge to the widespread adoption of PAPSS.
Building the Future of African Trade
The integration of CBDCs within PAPSS has the potential to play a transformative role in African trade. The combination of these technologies would address the aforementioned challenges to localized settlement, unlocking new opportunities for economic growth and integration. The significance of CBDCs in this context lies in their ability to provide a standardized, continent-wide currency conversion mechanism that transcends the limitations of individual central banks, mitigating many of the existing risks that hamper cross-border trade. The potential also exists for CBDCs to facilitate a shared digital infrastructure that paves the way for an unprecedented level of policy coordination among African nations. Some of the most compelling areas of convergence between CBDCs and PAPSS are as follows:
Enhancing Payment Efficiency and Security: CBDCs intrinsically offer high-speed transactions and robust security features. When integrated with PAPSS, they will allow real-time settlement of transactions, improving upon the existing settlement system that can take 24 hours. Moreover, the blockchain technology underpinning CBDCs provides a layer of immutability, reducing the risk of fraud and errors that plague traditional banking systems.
Stabilizing Regional Economies: CBDCs provide a more efficient mechanism for implementing and coordinating monetary policy. For instance, they enable central banks to directly manage the money supply and more effectively respond to local economic conditions. By using a shared digital infrastructure for CBDCs, central banks can coordinate their monetary policies, which can help harmonize economic cycles and reduce the likelihood of asymmetric shocks.
Building Trust in Regional Transactions: The transparency and traceability of CBDCs will enhance trust in cross-border transactions as each transaction recorded on a blockchain is verifiable, permanent, and secure. This level of transparency ensures that all parties can depend on each other to honor contracts and deliver goods, services and payments on time.
The Hurdles in Harmonizing Africa’s Digital Economy
While promising, the integration of PAPSS with CBDCs will come with myriad challenges. Foremost will be the technological disparity across the continent, where the varying levels of existing digital infrastructure and expertise risks creating a two-tier financial system, exacerbating existing inequalities. The coordination of regulatory frameworks poses another hurdle, as each nation's unique regulatory stance towards digital currencies and financial transactions must be navigated to forge a cohesive, continental policy. Moreover, there's the concern of cybersecurity, since the threat of cyber attacks will become more pronounced as financial systems move towards digitalization.
The combined potential of CBDCs and PAPSS to transform African trade is immense. It offers a vision of a more integrated, efficient, and stable financial ecosystem. While the journey towards this vision will be fraught with challenges, the path forward is clear. If navigated effectively, this financial transformation can position Africa as a leader in the global digital economy, heralding a new era of innovation and collaboration on the continent.