Bottoming Dollars - What Effect Will the U.S. Federal Taper Have On Africa?
19 February 2014
by William Clarke
Ghana's cedi and South Africa's rand are depreciating dramatically as the US slows down quantitative easing. But the US' move is not all bad news for Africa.
Earlier this month, the Ghanaian preacher Archbishop Nicholas Duncan-Williams led his followers in prayers for the recovery of the cedi. Duncan-Williams, a popular and controversial figure in the "health and wealth" movement - which teaches that financial blessings are the will of God - drew criticism on theological as well as economic grounds for this move.
But it's easy to see why Ghana's leaders might be crying out some heavenly aid. The cedi is at a record low against the dollar, having fallen by 4% so far this February after a fall of 17% in 2013. Down in South Africa, the rand is down 8% so far this year after a total drop of over 18% last year.
These numbers are enough to have any central banker down on their knees. But if you want to ascribe blame for Africa's plummeting currencies, one's attention might be better placed looking across the Atlantic, rather than up at the skies, to the almighty US Federal Reserve.
Putting the fear of God into African economies?
Shortly after the global financial crisis of 2007-8 broke, the US Federal Reserve started buying up huge quantities of bonds from banks.
This process, termed 'quantitative easing' (QE), increased the amount of cash in circulation in the hope of giving a boost to the economy, albeit at the cost of higher inflation and a weaker dollar.
Now, with the global situation improving, the Fed is preparing to sell those bonds back, choking off the money supply and sending the dollar back skyward against other currencies. This slow turning off of the pump is being termed the 'federal taper'.
The threat to African economies from the tapering is two-fold: firstly, their currencies will depreciate against the dollar, making imports more expensive; secondly, global investment on the continent may slow as dollars flows back into the coffers of the fed instead.
In response to its depreciating cedi, the Bank of Ghana raised interest rates two percentage points to 18% on 6 February, as well as introducing currency controls and encouraging the use of the cedi in domestic transactions.
However, such moves have so far failed to lift the Ghanaian currency from its slump, and South Africa has been similarly powerless to lift the rand's fortunes.
Is the federal tapering threatening Africa's nascent prosperity?
Blessings and curses
In answer to this question it is important first to note that the underperformance of the rand and cedi have been the exception rather than the rule among Africa's currencies, and there are important domestic reasons for their falls.
The Ghanaian government is struggling with a stubborn budget and current account shortfall as well as a debt-to-GDP ratio pushing 50% - very high by African standards. South Africa meanwhile is another outlier in sub-Saharan Africa due to its deep dependence on the financial industry and its strong economic links to Europe.
Furthermore, even if the currency contagion were to spread, the story would not be an unmitigated disaster. African net exporters such as Nigeria and Angola, for example, would stand to benefit from a stronger dollar, at least on paper. And Africa's commodity markets might even be hoping for a stronger dollar.
However, the bigger picture is a little more complicated. Africa's oil exporters tend to be riddled by the so-called 'Dutch disease' whereby the blessing of natural resources ends up being a curse as, amongst other things, the non-extraction-based sectors of the economy find themselves neglected and development is impeded.
In the long run, a weaker domestic currency can help cure this ill, but in the short-term the medicine could prove worse than the disease. Oil millionaires would certainly benefit from a stronger dollar but with their wealth likely to be slow to trickle down, consumers would struggle to afford the rising costs.
In Angola, where food is already jaw-droppingly expensive despite low median incomes, such price increases could be devastating.
For the moment, however, the point is moot. The healthy current account balances of Nigeria, Angola end Equatorial Guinea have allowed their currencies to stand strong in the face of the federal taper.
Nigerian Central Bank governor Lamido Sanusi was even confident enough to relax currency controls earlier this month, and although the naira has subsequently slid against the dollar, the impact has so far been muted.
Working in mysterious ways
Indeed, Nigeria's main worry seems not to be currency devaluation, but a drop off in investment. And investor inflows into Nigeria "have clearly slowed under the cloud of tapering," according to Gregory Kronsten and Bunmi Asaolu, strategists at FBN Capital.
However, the Nigerian Central Bank, claims that investor outflows were mostly 'hot money' - that is, investments from speculators on stock exchanges and other capital markets liable to be rapidly withdrawn when market conditions change.
This is not a problem most sub-Saharan economies - save for Nigeria and South Africa - have to worry about. "So called "hot-money" from the US has mostly negatively affected leading emerging markets with open capital markets rather than frontier market economies," Martyn Davis, CEO of Frontier Advisory, told Think Africa Press.
"The impact of QE tapering has thus little or no impact in many of these economies. Rather than external fiscal stimulus, commodity prices and private/sovereign financing has been underpinning their robust economic growth."
In fact, a defrothing of capital markets across the world could lead investors, who got used to eye-wateringly high yields during the Asian boom years, to seek out pastures new in Africa, which boasts 10 out of the world's 20 fastest growing economies, most of which have low national debts and rapid population growth.
"The corporate thrust into Africa is largely in consumer-facing sectors", continues Davis. "It is often all about demographics - capturing consumers and consolidating the nascent markets.
Capital seeks yield and this is often driven by growth. The increasingly challenging environment for foreign business in China may lead to MNCs [multi-national corporations] beginning to look toward Africa with greater interest."
Indeed, despite concerns about exchange rates and investment inflows, it is important to remember that the federal taper is not taking place in a vacuum.
US monetary policy is tightening because most economists are confident that the world economy is looking better than it has in several years. And although the short term may be painful, Africa is still well positioned to prosper in the current upturn.
ThinkAfricaPress