Afreximbank sees PAPSS tackling exchange rate volatility in Africa

The Pan-African Payment and Settlement System (PAPSS) has been described as one of the most promising initiatives to combat exchange rate volatility and fragmented payment systems within Africa.

A study by Afreximbank research, titled “Exchange Mechanism Toward an Efficient Payment and Settlement System,” sheds light on how PAPSS, launched to streamline cross-border trade payments, can reduce reliance on foreign currency exchanges and allow transactions to be settled in local currencies, mitigating associated risks and making trade more efficient.

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According to the findings, PAPSS is poised to be a key pillar for enhancing intra-African trade and creating a more accessible and cost-effective trading environment across the continent. The system’s integration is seen as vital for aligning with the broader goals of the African Continental Free Trade Area (AfCFTA), fostering deeper economic integration, and supporting regional trade growth. “PAPSS plays a crucial role in improving economic integration by mitigating exchange rate fluctuations,” the report states.

The research, based on data from 54 countries between 2004 and 2022, utilised advanced econometric techniques including instrumental variable arguments, dynamic system generalised methods of moments, and probit estimation. The results reveal several insights into how exchange rate mechanisms influence cross-border payment and settlement systems. For instance, the study found that a stable exchange rate environment has a positive impact on these systems, while countries with higher real effective exchange rates are less inclined to adopt them. Conversely, countries with a common currency mechanism are more likely to integrate cross-border payment systems, indicating that such systems promote regional economic cooperation.

“Countries with stable exchange rates are better equipped to implement cross-border payment systems, fostering smoother transactions and a more robust regional economy,” noted the report. Stable exchange rates build trust among businesses, encouraging more frequent and cost-effective trade transactions. On the other hand, countries with floating exchange rate systems are more vulnerable to uncertainties, transaction delays, and increased costs due to frequent price fluctuations and the need for hedging strategies. This, the study suggests, can impede the efficiency of payment systems and complicate cross-border trade.

The analysis underscores the significance of integrating exchange rate mechanisms with efficient payment and settlement systems to support intra-African trade. “The interplay between exchange rate stability and payment system efficiency is crucial for reducing transaction costs and risks, which ultimately enhances trade competitiveness,” the report asserts.

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While the adoption of exchange rate mechanisms might not always directly impact trade volume, it becomes significant when considering broader economic operations and integration. The findings emphasise that a common currency mechanism and well-structured cross-border settlement systems can lower transaction costs, reduce financial burdens, and make goods and services more competitive.

Policymakers are urged to prioritize the development of stable exchange rate mechanisms and integrated payment systems. “For AfCFTA and other regional economic policies to succeed, stable exchange rate mechanisms and effective cross-border payment systems are essential,” the report said. These measures will not only streamline trade but also promote sustainable economic growth, making intra-African trade more robust and resilient.