Closely tied to slack commodity prices, African currencies have suffered considerable instability over the past year. Central banks have had their work cut out for them dealing with the fiscal pressures of rising inflation, expensive imports and debt burdens.
As foreign companies look to operate in Africa, treasurers may find this volatile foreign exchange landscape unpredictable and risky. With the right banking partners, however, they can find a sound footing even in the trickiest of spots.
Volatility’s the word
What a year 2016 was: Mozambique’s metical (MZN) fell by over 30% against the US dollar, and the Angolan kwanza (AOA) lost almost 20% in the same period – its sharpest drop since September 2001. The Guinean and Congolese francs (GNF/CDF) and the leone in Sierra Leone (SLL) all weakened considerably – by 18%, 21%, and 27% respectively.
The value of Nigeria’s naira (NGN) notably collapsed by a third when the government removed its peg to the dollar last June; having depreciated about 37% to become the cheapest currency in Africa of 2016, although it now seems to be back on an upward trend.
Zambia’s kwacha (ZMK), in the meantime, seems to define the word “volatility”. Depreciating by over 40% in 2015, it became the third-worst performing currency in the world. It then rebounded – by nearly 20% in the first half of 2016 and a further 13% in the second – to become among the world’s best-performing currencies of last year.
What’s behind this volatility?
In Africa, the strength of currencies closely correlates with raw material prices. Since mid-2014 these prices have faced volatility of their own, as global demand for commodity exports has weakened. Growth in China – the major buyer of Africa’s raw materials – has continued to flatten. Considerable pressure has been put on local exchange rates as a result.
With fewer exports of oil and gas, for instance, countries are seeing reduced inflows of US dollars. This is having an impact on the stability of the local currency in countries that are highly dependent on the dollar. The American shale revolution has played its part, cutting into the revenues of major oil and gas producers such as Angola and Nigeria, as well as those of budding exporters such as Ghana, the Republic of the Congo and Mozambique (for gas).
The commodity price crash has also had a considerable impact on macroeconomic stability. In 2016, real gross domestic product (GDP) growth in sub-Saharan Africa (SSA) is estimated to have been the weakest since the 2008-09 global financial crisis. Average government deficits in the SSA region, meanwhile, have surged – to 4.1% in 2014, 5.7% in 2015 and 6.3% in 2016.
Particularly high deficits are those of Ghana (8.7%), Mozambique (11.1%), and Liberia (12.1%). These fiscal constraints, in turn, have the capacity to hurt sovereign ratings: since January 2017, when it missed an interest payment of US$59.8m on a sovereign bond, Mozambique has been rated as “SD” (selective default) by credit ratings agency (CRA) Standard & Poor’s (S&P) Global Ratings. Such economic worries dampen investor confidence in both the economy and the local currency.
A tough time for central banks
Aside from having to weather this tricky situation, central banks across the continent must deal with further challenges created by currency volatility. Chief among these is a rise in inflation rates. Since the end of 2016, these have been hovering around the 20% mark in Mozambique, Sierra Leone and Nigeria; in Angola, the Congo and the Central African Republic inflation has been pushing 40%.
Weaker local currencies not only increase local prices for consumer products; they also make it more expensive for developing African economies to buy the machinery and capital goods crucial for infrastructure developments. In recent years, for example, the value of Kenya’s imports have been twice as high as that of its exports – a result of spending on ambitious, and increasingly expensive, transport and pipeline projects.
Central banks in these countries then face a difficult decision. Either they can tackle this inflation by raising interest rates – and risk stifling economic expansion in countries already struggling with low growth. Or they can spur growth by keeping interest rates low – but then have to stomach even higher inflation and the chance of more currency devaluations. They cannot even count on the economic lifeline usually offered by currency depreciation. Weaker exchange rates normally boost a country’s exports, by making them more competitive on global markets. However, since mid-2014 this effect has been mitigated by the worldwide glut of raw materials: African supply has simply not met enough demand.
Central banks have also been left with a serious depletion of their foreign exchange (FX) reserves. These reserves have been spent on rising import costs – as Kenya, Namibia and Zambia have all discovered – and further drained defending local exchange rates. Some countries, such as Ghana and Mozambique, have even had to use their FX reserves to service rising external debt obligations.
In the years following the global financial crisis, countries across Africa took advantage of relatively cheap financing to issue record amounts of debt, in the form of foreign currency-denominated bonds. However, now that maturities are approaching refinancing may be difficult in an environment of weakened local currencies. In certain states, this could even pose the risk of a debt trap. In order to meet its external obligations, Zambia issued three government bonds in 2012, 2014 and 2015, amounting to a total of US$3bn. But as the kwacha began to lose value – depreciating by about 45% in 2015 alone – the Zambian government found itself at risk of struggling with its debt burden. Last year, it had to turn to the International Monetary Fund (IMF) for assistance.
What can treasurers do in this environment?
Central banks are not the only ones that must cope with currency volatility. Companies looking to work in Africa must mitigate the significant effects of a shifting FX landscape, as it can lead to increased expenses for cross-border trade, investments and day-to-day operations.
This may limit treasurers to staying put in those areas of Africa still enjoying relative currency stability. The countries of the African Financial Community (CFA) zone – comprising Benin, Burkina Faso, Cameroon, Central African Republic, Chad, Republic of the Congo, Equatorial Guinea, Gabon, Guinea-Bissau, Ivory Coast, Mali, Niger, Senegal and Togo – are all faring comparatively well. They can count on the stabilising influence of a peg to the euro: not only does this help to keep a lid on inflation, but it also reassures foreign investors, and eases the flow of foreign trade – above all with Europe.
Over the long term, treasurers could also find greater currency stability in those countries making steps to diversify their economies. Ivory Coast, Kenya, Botswana, Cameroon and Gabon, for instance, are moving away from a reliance on low-value, volatile commodities, while developing a more balanced export base that includes higher-value manufacturing and services sectors. The aim is to attract more foreign investors who can further support the stability of the local currency.
In the shorter term, treasurers may even look to those countries, such as Tanzania and Ghana, where tourism is helping to stabilise the local currency with inflows of foreign exchange. South Africa’s rand (ZAR) enjoyed a similar – albeit brief – experience thanks to the effects of the FIFA World Cup in 2010.
Necessity may drive treasurers to move beyond the “safe havens”, however. After all, business opportunities in new frontier markets may be too important for companies to miss.
Treasurers must therefore ensure that they put in place adequate currency-hedging strategies. They need their bank to be able to manage FX risk and deal comfortably in spot trading, and offer access to the full range of exotic local currencies needed for transactions and deposits on the ground.
They particularly need their banking partner to have a deep understanding of the unique needs and challenges of diverse countries and regions. Only longstanding experience of the local financial landscape and close relationships with local African financial institutions can ensure that adequate trade finance is provided, that funds are made available and cleared on time, and that pricing on FX trades is competitive.
The ups and downs of African currencies will doubtless continue to make headlines. Yet with the right measures in place, foreign treasurers can continue their work – even in a shifting FX landscape.
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