the French Treasury, where they pool 65 percent of their reserves in an overdraft facility and which helps the central banks to maintain the fixed parity to the euro. Furthermore, the central bank (BEAC or BCEAO) has to maintain a foreign exchange cover of at least 20 percent of its liabilities. Secondly, the two communities abide by a set of fiscal and monetary rules designed to reduce the risk of incurring large fiscal and balance of payments deficits. In this context, credit and advances from the central bank to each government cannot bypass more than 20 percent of its revenue during the previous year. Thirdly, the French Treasury has historically guaranteed convertibility of the CFA franc to the French franc before 1999 and to the euro after 1999, with no monetary obligations for either the Bank of France or the European Central Bank. According to some experts, this feature of the CFA franc relationship constitutes a contingent liability of the French Treasury in case of a rundown of the outstanding balances in the operations accounts of the two regional central banks (Hadjimichael and Galy, 1997).

Since the introduction of the euro in 1999, there has been widespread interest on whether the new currency would be a boon or a bane for Africa (Irving, 1999). Arguments that it would help macroeconomic stability, lead to higher investment and trade flows, and spur regional integration were contrasted with fears that the euro would result in a loss of export markets and slow down local growth. There was particular concern that volatility in the euro-dollar exchange rate would create uncertainty in the CFA zone. Nevertheless, this paper tries to address some of the exchange rate issues by taking stock of events five years after the introduction of the euro.

The remainder of the paper is organized as follows. The next section provides an overview of the PPP approach to measuring misalignment. Section III provides the empirical results and gives quantitative measures of misalignment in UEMOA and CEMAC from 1999 to 2004. Section IV uses cointegration techniques to provide a single equation estimation of the long-run equilibrium exchange rate (LRER). Section V summarizes the paper.

# **II.   MEASURING MISALIGNMENT**

## **A. LITERATURE SURVEY**

There exists a rich and significant literature on methodologies to calculate exchange rate misalignment, with particular relevance to the CFA zone, and the implications of alternative approaches, but most of the work was done in the context of the 1994 CFA devaluation (Hinkle and Devarajan, 1993; Kiguel and Ghei, 1993; Devarajan, Lewis, and Robinson, 1993; Baffes, Elbadawi, and O’Connell, Ahlers and Hinkle, 1999). A variety of country studies estimating the long-run equilibrium exchange rate have been done on African countries, especially South Africa, Cote d’Ivoire and Ghana (MacDonald and Ricci, 2003; Bogetic et al, 2004; Opoku Afari, 2004). However, there has been little empirical work on the effects of the introduction and consequent appreciation of the euro on the real effective exchange rates of the CFA zones and the implications of any CFA appreciation. However, one recent study (Ouattara and Strobl, 2004) uses dynamic panel analysis to find that foreign aid inflows do not generate Dutch disease effects in 12 countries of the CFA zone. This work will try to fill the gaps in the recent literature.

## **B. METHODOLGICAL OVERVIEW  AND DATASET**

The measurement of exchange rate misalignment is a complex exercise, sensitive to the analytical framework and methodology used. Given the impossibility of direct observation of the equilibrium exchange rate, a plethora of methodologies have been developed to quantitatively 6