May 16, 2022

Explained | Why countries like the Central African Republic are adopting cryptocurrencies as legal tender

A transition towards cryptocurrencies by the Central African Republic and El Salvador is spurred by the urge to circumvent inflationary pressures and move away from colonial currency mechanisms. However, prerequisites such as internet and financial digital literacy make a case for inclusivity cumbersome

A transition towards cryptocurrencies by the Central African Republic and El Salvador is spurred by the urge to circumvent inflationary pressures and move away from colonial currency mechanisms. However, prerequisites such as internet and financial digital literacy make a case for inclusivity cumbersome

The story so far: On April 27, the Central African Republic (CAR) became the second country after El Salvador to adopt Bitcoin as legal tender. President Faustin-Archange Touadera said the measure would enable “strong and inclusive growth” and place the African country on the “map of the most courageous and visionary countries in the world”. Having a population of 5 million, CAR is among the poorest and most economically fragile countries on the globe. As per World Bank estimates provided in July 2021, 71% of its population was living below the international poverty line of $1.90/day.

The International Monetary Fund (IMF) said adopting the unregulated asset as a legal tender posed major legal, transparency and economic policy challenges, Bloomberg reported. The global body in an e-mail response said, “IMF staff are assisting the regional and CAR’s authorities in addressing the concerns posed by the new law.” 

Recently, several countries have considered instituting laws that regulate the use of cryptocurrencies, particularly those not having well-devised currency mechanisms and experiencing prolonged inflation. IMF’s Managing Director Bo Li had said in April that the unregulated asset witnessed “substantial action” in Kenya, Nigeria, South Africa, Ghana and Tanzania.

Geopolitical currents and dependence on varied colonial-era currencies have further provided stimulus. 

Cryptocurrencies are highly volatile assets and have acquired popularity for their unregulated nature. At the time of writing, Bitcoin fell to its lowest level since July 2021 at $29,731. It was an all-time high of $68,000 in November 2021. This volatility has established concerns over the potential impact on a country’s macroeconomic stability, especially those with weak socio-economic fundamentals.

How is this about geopolitics? Where is the ‘colonial baggage’? 

The two countries that regularised Bitcoin as a legal tender do not have a currency of their own.  

El Salvador uses U.S. dollar and CAR’s franc is the mutual currency for 14 African nations—Benin, Burkina Faso, Côte d’Ivoire, Guinea-Bissau, Mali, Niger, Senegal, Togo, Cameroon, Congo, Gabon, Equatorial Guinea and Chad. Together these countries—most of which were once French colonies—constitute the ‘Franc Zone’. Convertibility, that is the ability of a currency to be exchanged with other global currencies, is guaranteed by France. In other words, franc can be exchanged into foreign currencies via the exchange market of Paris, creating a dependency on the European country.

Also, all coins and banknotes are printed under a manufacturer’s contract with the Bank of France, following instructions from the African central banks. A blogpost by the London School of Economics states, “It is a colonial currency, born of France’s need to foster economic integration among the colonies under its administration, and thus control their resources, economic structures and political systems.” The blog says that the two central banks in the region, namely, Central Bank of West African States (BCEAO) and the Bank of Central African States (BEAC) are required to deposit 50% of their forex reserves in a special French Treasury ‘operating account’. France’s Ministry of Europe and Foreign Affairs maintains that the mechanism provides stable economic framework for implementing economic policies in these regions. All countries are free to opt out of the mechanism.

For some countries, the move towards regulating and permitting cryptocurrency was a means to circumvent the sanctions and embargos imposed on them, such as Cuba. As a consequence of the blockade imposed by the U.S., Cubans are cut off from global financial systems and cannot acquire financial instruments as debit or credit cards, in turn, struggling to go abroad and obtain materials and services from outside. The Caribbean country issued regulations in April for crypto providers to obtain licence to continue providing crypto-related services.  

Experts told Bloomberg that a possible explanation for Touadera’s announcement could be his entwinement with Russia. In 2020, Putin had sent paramilitary groups to protect Touadera against rebel groups in the country. 

Can cryptocurrency reverse economic problems? 

There is potentially a direct relationship between inflation and countries permitting the use of cryptocurrencies. Cryptocurrencies bear the potential to convert inflation-related headwinds from legal currencies into tailwinds. Take, for instance, a situation in an inflation-riddled economy where price of flour has reached $3/kg from $1/kg. The purchasing power of the dollar takes a hit because of the price rise. However, Bitcoin, which say rose 10% the previous day and is unaffected by the local conditions, would endow greater purchasing power to the consumer and dodge inflation.

This potentially direct relationship is particularly relevant for CRA. As per the IMF, headline inflation in the country is expected to accelerate to 4% in 2022 because of rising food and fuel prices. Food, fuel and budget support shocks are also expected to weaken the country’s balance of trade.

Earlier this year, the IMF had urged El Salvador to limit the scope of the unregulated asset. “They (IMF Executive Board) stressed that there are large risks associated with the use of Bitcoin on financial stability, financial integrity and consumer protection, as well as the associated fiscal contingent liabilities,” their assessment read.

Despite a strong economy, El Salvador’s public debt remains persistently high. “This situation is unsustainable—it crowds out private investment and limits resources for social and infrastructure spending, all impediments to growth,” the Fund had said. It added that the country would essentially require more private investments and healthier public finances.

In this case, and also with relevance to other economies of the kind, it becomes imperative to fully hedge the unregulated asset in order to secure it from uncertainties. Risks related to value swings alongside cybercrime and theft run the risk of households and business losing a large amount of wealth. 

For countries like CRA, risks associated with paying taxes in cryptocurrencies would be exposed when taxes are paid using crypto-assets but expenditures remain in local currency. For example, the government collects $100 worth taxes using crypto denominations but a downward slide of the asset makes available $40 to spend.

Additionally, unlike equities or currencies, cryptos are not subject to a definite mechanism and are speculative assets, therefore, central banks would not have any reference point to devise their interest rates in accordance with their domestic requirements. The IMF argues that the underlying anonymity in crypto-transactions may create certain data gaps for regulators. Blockchains may help trace the transactions but not the parties involved. Hence, it could potentially be used for money laundering, terrorist financing or other illegal activities.

Is there a case for financial inclusion?  

Leaderships in both El Salvador and CAR have maintained financial inclusion as the prime rationale for according Bitcoin the status of a legal tender. 

Internet penetration has helped the unregulated assets become popular. Scaling up access to internet is also the central prerequisite for bringing the unregulated asset into the mainstream. Banknotes do not require any such prerequisite and hence are widely in circulation. As per the International Telecommunication Union, 29.5 million people in the African continent were using internet in 2020—roughly 22.7% of the overall population. Barely 10% of the population in CAR had access to the internet and 55% in El Salvador, as per World Bank. 

Another challenge to the stated objective is access to financial services and related literacy. About 70% people in El Salvador did not have access to banking services whereas only 14% in the CAR were part of the mainstream banking structure. Considering the low levels of financial and related digital literacy, and overall gender inequality in CAR, a case for inclusion appears cumbersome.

  • On April 27, the Central African Republic (CAR) became the second country after El Salvador to adopt Bitcoin as legal tender.
  • Recently, several countries have considered instituting laws that regulate the use of cryptocurrencies, particularly those not having well-devised currency mechanisms and experiencing prolonged inflation
  • Leaderships in both El Salvador and CAR have maintained financial inclusion as the prime rationale for according Bitcoin the status of a legal tender

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