African countries are finding it increasingly difficult to obtain hard currencies to buy imports and make payments to overseas investors as the region becomes an unintended victim of the developed world’s post-pandemic fight against inflation. Ironically, the situation has kindled inflation rates as high as 30% as the continent’s own currencies weaken, and there is no quick fix: it would take increased exports and creation of domestic production to replace imports to counteract the trend.
“The proximate reason for a dollar shortage is the pressure on the balance of payments as a result of the so-called rolling crisis impacting many African economies,” says Christopher Adam, professor of development economics at the University of Oxford. The crises stem from pandemic-related supply-chain disruptions and the subsequent global recession that resulted in sharply lower prices for Africa’s key exports and also a halt in tourism, a key source of dollar inflows, he adds.
“The resurgence of global inflation and the resulting tight monetary policy has seen prices for key imports and the cost of foreign borrowing rise sharply,” Adam says. “On top of this, Russia’s invasion of Ukraine saw prices for oil, food and fertilizer spike.”
Local importers and non-resident investors typically require hard currencies–mainly U.S. dollars–to respectively pay suppliers or repatriate investment proceeds. In countries with currency controls, the dollars come from central banks, which obtain them from exports, overseas remittances, overseas loans and tourism.
But several months of dollar outflows from the economies of some of Africa’s top investment destinations like Egypt, Nigeria and Kenya, with little or no boost to exports have put a strain on central-bank foreign exchange reserves and left local currencies under immense pressure. The Egyptian pound has lost 20% of its value against the dollar this year while Nigeria’s naira is down 39% since June 14, when the central bank removed the peg against the greenback and unified multiple foreign-exchange rates. The rising costs of living as imports become more expensive in local-currency terms has increased operating expenses for companies, slowed economic growth and discouraged fresh investment. Whether a country maintains currency controls or not, the result is much the same.
“If countries seek to run a fixed exchange rate, then the shortage may be tangible, but if the exchange rate is flexible, it presents itself as a sharp depreciation” in a domestic currency, says Oxford’s Adam. What the African economies need is a resumption of investment that would directly ease the hard-currency shortage and–if correctly targeted–allow the countries to increase their output of exports and invest in capacity to replace imports with domestic goods. That is not going to happen overnight in a world where advanced economies will grow no faster than 1.4% through 2024, according to the International Monetary Fund (IMF) and where U.S. Treasury bonds yield about 5% for maturities of two years or less, with no currency risk for dollar-based investors. Global growth, which was 3.4% in 2022 is projected to slow to 2.8% this year and 3% in 2024, limiting investor appetite for risk.
Interventions in the foreign exchange market to ease the pressures have helped but also significantly drained foreign-exchange reserves, fueling other control measures, including multiple exchange rates, increased hard-currency rationing and import deals that rely less on foreign exchange.
The International Monetary Fund suggested several steps governments can take to mitigate the effects in an April outlook for Sub-Saharan Africa, but all of them will require sacrifices by people in the affected countries. Where inflation is a result of depreciating currencies, policymakers can tighten monetary conditions, usually achieved by raising interest rates; that is good for luring in overseas investors, but a problem for domestic borrowers. Governments running budget deficits can trim them, which would require spending reductions or higher taxes, neither popular with voters. A more satisfying solution would be accelerating economic growth and renewed interest from overseas investors, but that is unlikely until the U.S. Federal Reserve and other major central banks finish raising interest rates and begin to show signs of reducing them.
“In the meantime, dollar-dependency will remain, and the only sustainable method for easing the pressure on the balance of payments is by increasing exports of goods and services and by developing the capacity to produce domestic substitutes for imports,” according to Adam.
Dollars, Euros and Yen
Most African countries fall within the low- and lower-middle-income World Bank brackets, which mean they require imported capital goods like factory machinery and agricultural equipment to power their economies. Payments are typically in dollars, euros and yen, which puts persistent pressure on local currencies. To compensate for the foreign-exchange risk, overseas investors seek higher yields on domestic-currency-denominated debts and stock-market returns that significantly surpass inflation levels.
“If local rates at 9% are not attractive to domestic investors given high inflation rate, there is no reason foreign investors should be attracted to it,” says Abdulazeez Kuranga, macroeconomic strategist at Lagos-based Cordros Securities.
Among the leading African economies, No 3. Egypt’s balance of payments deficit–which includes trade in goods and services, investment flows and asset transfers–was $10.5 billion in 2022, a reversal from the previous year when the financial transactions of the country with the rest of the world generated an inflow of $1.9 billion. That reflected, at least in part, investors pulling their funds out, central-bank data show, likely to take advantage of rising interest rates in developed countries that were reversing easy-money policies instituted during the Covid-19 pandemic.
The Egyptian pound has been devalued three times since Russia invaded Ukraine in February 2022, but the scarcity of the dollars persists, fueling demand at the black market where the hard currency is more expensive.
In Nigeria, Africa’s largest economy, the balance of payment deficit stood at $840 million in 2022, according to the central bank, following a surplus of $3.75 billion the previous year. Africa’s top oil exporter benefited from rising international crude prices, but a plunge in foreign investment inflows to the lowest level in six years has dealt a blow by causing delays in forex processing.
Nigeria has a long history of tight exchange-rate regimes. But President Bola Tinubu, inaugurated in May, quickly moved to unpeg the naira from the dollar, end costly fuel subsidies and overhaul the multiple-peg currency system, which included suspension of Central Bank Governor Godwin Emefiele. The suspended banker, currently in the custody of Nigeria’s secret police “for some investigative reasons,” oversaw the replacement of high-value banknotes with new ones a few months prior to Tinubu’s election, causing an acute shortage of circulating currency in the cash-based economy.
The dollar scarcity extends to other countries, including in Ghana, Zimbabwe, Zambia and Kenya, the last of which struck a deal this March with oil exporters to temporarily ease its hard-currency shortage.
The arrangement allows the continent’s seventh-largest economy to import petroleum products on credit from Saudi Arabia and the United Arab Emirates for six months, putting a hold on the country’s monthly fuel import bills that run into hundreds of millions of dollars.
“When people were lending money to Egypt, Nigeria or Kenya in recent years, there were a lot of dollars coming into their economies, keeping their currencies strong. When lending to those countries stops, the flow of dollars stops and suddenly there is no support for those currencies anymore,” Charlie Robertson, head of macro-strategy at the investment firm FIM Partners. “We are seeing countries react and have to react because they are not getting dollars anymore.”
Consumers Pay
Whether caused by market forces or changes to currency controls, the resulting devaluations are punishing consumers, who are having to cut back on imports. For instance, the value of imports to Nigeria was down 6% in the first quarter from the similar period a year ago, largely the result of falling demand for boilers, machinery and appliances. “The currency is weakened significantly to try to improve the current account so there is no such an outflow of dollars from their economies,” says Robertson. “So people stop buying so much foreign stuff.” The combination of weakened currencies and flagging economic growth provide mixed signals for investors.
In Nigeria and Egypt where the average nominal half-year returns of stocks were respectively 18.96% and 21.01% against S&P 500’s 15.91%, the weakened currencies mean foreign investors can buy more equities for a given amount of hard currency than in the recent past.
The sub-Saharan economy is still growing, according to the IMF, although it is projected to decelerate to 3.6% from 3.9% in 2022. A pickup to 4.2% in 2024 might allow for profit growth that would support stock prices in some sectors, according to Kuranga.
“In Ghana, growth is expected to increase in 2024 relative to 2023 primarily driven by the services sector amid the low base effects from the prior year,” says Kuranga. “Investors can look into companies operating in the services sector given that they are expected to benefit the most in terms of earnings.” The situation in the local-currency credit markets is more dire.
Two weeks ago, Nigeria’s central bank offered one-year treasury bills with an interest rate of 8.24%, surpassing the 5.33% yield on equivalent debt in the United States. But with inflation running at an annual rate of 22%, that generates a negative real return on investment. This was also the case in Egypt, where the central bank sold treasuries this week at 23.5% against an inflation rate of 32.75%.
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