India-First-Global-Insights-Analysis -Sharing-PlatformIndia-First-Global-Insights-Analysis -Sharing-Platform

African exchange rate: Sliding currencies stoke inflation

, July 13, 2023, 0 Comments

African currencies have lost ground against the US dollar this year, further driving inflation in the import-reliant region. Depleting dollar reserves have left policymakers with limited options to arrest the decline.

Sub-Saharan African currencies are on a downward spiral against the US dollar this year, spelling trouble for citizens and businesses alike.

“We are unable to buy the same amount of goods we used to buy, our capital and trade volumes have drastically fallen pushing our businesses towards bankruptcy,” said Joseph Obeng, president of the Ghana Union of Traders Association (GUTA).

Interest rate hikes in the US — which is driving away investors in pursuit of higher returns toward US assets — and weak demand for African exports amid global recession worries have been dragging down African currencies.

Local citizens are decrying higher prices of imported goods leading to high costs of living while importers are complaining about their inability to source enough goods due to the decline in the value of their local currencies.

When currencies weaken against the greenback, imports become expensive as they are mostly denominated in US dollars.

“We are unable to make profits since our customers no longer have the purchasing power to patronize our businesses,” Obeng said.african-currencies-marketexpress-in

Why are African currencies losing value?

Although the question is simple, there are no easy answers. A mix of both internal and external issues has been behind the continuous decline in African currencies. Most African economies have been unable to recover fully from the economic disruptions caused by the COVID-19 pandemic.

“Basically a stronger dollar can lead to capital outflows as investors seek to get better risk-adjusted returns on their investments and they would get that back in the US. As capital flows out of a country, local interest rates will rise and that’s just to maintain parity,” Stephen Akpakwu, head of sovereign advisory at Crossboundary Advisory, told DW.

Many Sub-Saharan countries depend on a narrow range of commodities for foreign exchange. This means that when global demand for those goods falls, the value of their currencies drops too due to a drop in foreign income.

The global economic slowdown due to the Russian war in Ukraine has resulted in lower demand for African exports, thereby hurting foreign exchange earnings and pulling down local currencies. The war has also partly driven up import costs for food and fuel, further depleting the foreign exchange reserves in the region.

Fiscal deficits — the shortfall in a government’s total income compared with its expenditure — have also been partly blamed for causing higher demand for dollars. About half of the countries in Sub-Saharan Africa had deficits exceeding 5% of gross domestic product last year, putting pressure on their exchange rates, the International Monetary Fund said.

The Nigerian naira is the biggest loser, falling more than 70% against the dollar this year, primarily after Nigeria’s central bank removed trading restrictions on the official currency market.

What are the consequences for African economies?

With more than two-thirds of imports in most Sub-Saharan African countries priced in dollars, the region is highly sensitive to a strengthening dollar.

“A 1 percentage point increase in the rate of depreciation against the US dollar leads, on average, to an increase in inflation of 0.22 percentage points within the first year in the region,” the IMF said in a blog in May. “There is also evidence that inflationary pressures do not come down quickly when local currencies strengthen against the US dollar.”

With 60% of external debt in US dollars in Sub-Saharan African countries, declining currencies are making it more costly to service those loans.

”You have a real issue with debt. So your external debts in terms of the nominal service cost will go up if your local currency depreciates. It would actually cost you a lot more to service the debts that you currently have,” Akpakwu said.

What are governments doing to address the situation?

Different governments have taken different measures to prop up their currencies. Some governments have resorted to implementing tighter monetary policies, including hiking interest rates. Many central banks have also tried to boost their currencies by pumping in dollars from their reserves in the local foreign exchange market, but with their reserves depleting fast, they are left with limited options.

In Kenya, the government is aiming to collect more revenue by raising taxes to address budget deficits and cut down on borrowings in dollars.

In Nigeria, President Bola Tinubu announced an end to the country’s multiple exchange rate system which was used to artificially keep the naira strong. As a result, in June, the central bank lifted trading restrictions on the official market, driving down the naira to a record low.

Ethiopia has opted for more stringent measures such as imposing bans on foreign currency transactions by local businesses.

Akpakwu says governments can still do more by prioritizing local currency financing to insulate themselves against exposure to increased exchange rates. He further adds that governments must diversify their manufacturing abilities to avoid an overreliance on commodity exports by introducing industrial policies that drive growth in different sectors.

Editor’s note: The article has been corrected to state that Stephen Akpakwu works for Crossboundary Advisory, not Crossboundary Africa.