How will the emerging market downturn play out in Africa? The region’s asset markets have been fairly robust – so far. Instead the pressure is being felt in African currencies. In fact, sub-Saharan Africa has the makings of a currency crisis.
From African Banker
There are some pretty strange things happening to Africa’s currencies.
Take a look at Zimbabwe. In January this year the Zimbabwean monetary authorities announced that with immediate effect an extra four foreign currencies would all be legal tender in Zimbabwe. That meant you could buy your bread with Indian rupees, your fish with Japanese yen, your noodles with Chinese yuan and your beer with Australian dollars.
Those four new legal currencies join the other five foreign currencies that are already legal in Zimbabwe – the Botswana pula, the UK pound, the euro, the rand and the US dollar. So you now have a choice of nine currencies in Zimbabwe – and not one of them is the ‘national’ currency, the Zimbabwe dollar, which was abandoned after collapsing amid hyper-inflation in 2009. In fact most people in Zimbabwe use either the US dollar or the South African rand, and have been doing so for a long time: the fact that the country does not have its own currency and therefore cannot use most of the usual levers of monetary policy no longer seems unusual.
In neighbouring Zambia it has been a very different story – on the face of it at least. Back in 2012 a new ruling suddenly banned the use of the US dollar for domestic transactions – with a penalty of ten years in jail for doing so. Then in May last year the authorities added another restrictive rule designed to defend the kwacha – this time a regulation that forced all businesses to remit foreign currency profits back home into local currency. It was highly unpopular, and many thought the only real beneficiaries were local banks, who made a tidy profit changing kwacha into foreign currency and then back again.
Hate the dollar … love the dollar … it may all sound a bit contradictory, but in fact it is not. Zimbabwe and Zambia have both seen their currencies under pressure. Zimbabwe’s response was to abandon the domestic currency altogether. Zambia’s was to tough it out, and then give up just the same – because in March this year the Zambian authorities suddenly reversed policy and dropped all foreign exchange regulations. As many countries in the region are finding out, you can’t beat the currency markets.
But why is it all happening? When Zambia introduced its currency ban the kwacha was at an all time high. In 2012 and for most of 2013 other important African currencies like the Nigerian naira, the Ghanaian cedi and the Kenyan shilling were also strong. For a long period the South African rand seemed to be the only African currency that was depreciating in the face of tougher global economic conditions.
Now that is changing. The downturn in sentiment towards Africa that many forecast for last year is actually happening this year – and the effect is being seen in currencies. The Zambian kwacha has been one of the worst performing African currencies in 2014, depreciating 13% against the dollar by the end of March. The Ghanaian cedi has also been in steep decline against the US dollar, with the second worst depreciation of any African currency over the last 12 months (only the New Sudanese pound was worse).
These are the two of the three big losers so far this year – although there may be others to follow. The other has been the South African rand which has been on a declining track since the beginning of 2012, having fallen from less than seven rand to the US dollar to over 11 at the beginning of this year. The rand has stabilised and even made a little ground during 2014, although whether it has touched bottom or will resume its depreciation is very much an open question.
There is no one answer to the question of why African currencies are coming unstuck. Many things contribute to currency movements, including interest rates, government finances, and wider confidence levels. One big part of the story is the slowdown in other, larger emerging markets, especially China, a slowdown which is having a knock-on effect in Africa’s increasingly China-dependent economies. Global monetary policy is also part of the story – most investors now think that the US Federal Reserve and the Bank of England will soon cut the amount of liquidity they pump into their economies, and that in turn cuts the amount of money that flows out and into emerging markets. But domestic issues are probably the most important of all. Africa’s debt and government deficits are starting to worry investors, who have suddenly grasped that the Africa good news story may have got a little ahead of itself.
The economic slowdown in China, India, and other commodity-consuming countries is itself contributing to the fall in commodity prices. This has been particularly hard on Africa: the price of copper, which accounts for over 80% of Zambia’s export earnings, has fallen by a third since 2011. That means less tax income for Zambia’s government, less profit and investment for Zambian industry, and less demand for Zambian currency.
But can the fall in commodity prices account for the widespread pressure on currencies? Hardly: some commodities have staged something of a recovery this year, but that has not been accompanied by a revival in currencies. The price of cocoa, for example, has been rising moderately for twelve months. The price of aluminium is slightly higher than it was a year ago. Both of these are important exports for Ghana – but the rises have done nothing to support the Ghanaian cedi.
It seems that something more fundamental is at work. The one thing that most of the weak-currency economies have in common is that they are running government spending deficits – that is, their governments are spending more than they receive in tax – and they are also running current account deficits, which means they are importing more than they are exporting. The current account deficit in particular is getting worse right across the region. Ten years ago the average deficit of sub-Saharan Africa was less than 2% of GDP. Now it is over 4%, and in some countries it is much worse – Ghana’s current account deficit is over 13%. Fiscal deficits – the amount the government has to borrow to pay for domestic spending – are also getting worse. Ghana’s fiscal deficit is now over 10%, which is double the amount that investors would consider normal.
These deficits have not appeared overnight – what has changed is the investor attitude towards them. Deficits of 10% plus might be sustainable in a period where global interest rates were very low (meaning that the cost of financing these deficits was also low) and expected to stay that way, and where regional growth rates were very high (meaning that it looked as if Africa could always grow its way out of trouble). But both of those things have changed. Interest rates are already high in emerging markets and set to rise in the US and in Europe, while African growth rates are falling. Average GDP growth sub-Saharan Africa is set to fall to around 5.5% this year, according to the IMF, down from an average of over 7% in the last decade.
So what next for Africa’s fragile currencies? The countries under the most pressure are already having to pay much higher long-term interest rates on their borrowing – Ghana’s ten year bond is currently paying just under 10% – and ‘policy rates’ (the domestic borrowing rate set by the central bank) are very high at 18%. For countries with floating exchange rates, governments may also return to capital control measures designed to lock capital in the country – the kind of policy that Zambia attempted, and that Angola, Mozambique and Ghana are all still following.
Also possible is that countries will try to peg their currencies against an external benchmark, the kind of policy that was familiar up until the early 1990s. The problem with a pegged currency is that a dual currency system emerges, with the market exchange rate being much lower than the official rate. The main beneficiaries of the dual exchange rate are traders with political connections, able to buy at market rates and then sell at the official rate.
What is fairly certain is that as currencies depreciate, domestic inflation will grow. African inflation is usually generated by import prices, which increase as the currency depreciates. South Africa is the sub-Saharan economy that is arguably the least vulnerable to imported inflation, thanks to its diversified domestic economy, but already South Africa has inflation running at around 6%, which is the upper limit of the central bank’s inflation target. Ghana has inflation running at over 13% – currently one of the world’s highest rates.
Also likely is that the performance of international corporations will suffer. Companies that report profit and loss in strong currencies but receive revenue in depreciating local currencies will find that sub-Saharan Africa is an increasingly difficult place to do profitable business. For example, the mobile telephone operator Zain whose African operations are now concentrated in Sudan and South Sudan earlier this year had to announce a dramatic fall in profits, due to the falling value of the Sudanese pound (which was devalued by 30% in November last year). Zain saw almost $150 million wiped from its profits when it released its accounts early this year – and that was a repeat of the performance the previous year, when the Sudanese currency fell 51% against the US dollar in continuing conflict following the independence of South Sudan.
However, not all regional currencies performed badly. The three most important African markets for most companies and most investors are South Africa, Kenya and Nigeria. And while the South African rand has been one of the continent’s currency losers for the last two years, the Nigerian naira and the Kenyan shilling have been much more robust. Although the Kenyan shilling did come under pressure briefly in 2011, it has been stable since. The naira has depreciated slightly in recent months, but in the main it has been stable since 2009.
Will this stability continue? For both countries, the most important factors will be the state of public finances, and confidence in the monetary authorities. And on both counts, it is Nigeria that is looking vulnerable.
As widely reported, Nigeria recently restated the size of its GDP in a statistical exercise endorsed by the IMF. Like many other African countries Nigeria’s GDP has proved to be seriously underestimated – the recent restatement has doubled GDP making Nigeria the biggest economy in Africa. But this restatement may have some unexpected side-effects with an impact on the currency.
Nigeria’s new enlarged GDP may have made the country look richer – but it has also revealed some weaknesses in the economy. The first is that the amount of tax Nigeria is managing to collect is very low for such a large economy. Because the amount of tax collected does not change when the GDP figures are restated, total tax revenues as a proportion of GDP have now halved to 12% – very low for any country, and exceptionally low for an economy where the government needs to spend heavily on infrastructural development, education, and government services. And most of that tax comes from oil and gas, even though in the new GDP accounts oil and gas now account for less than 15% of the economy. Suddenly the ability of Nigeria to finance itself through tax looks less convincing. Nigeria will have to borrow more, and that is exactly the kind of negative change that drives a depreciating currency.
Perhaps more significant is the way that Nigeria’s trade surplus suddenly looks less impressive. Before the restatement of GDP the country had a healthy surplus of 3.2%. Now the surplus is only 1.8% (and it is falling). The day when Nigeria starts to record a trade deficit is not far off. Again, already investors will be calculating that Nigeria is going to need more external financing, and sooner than expected.
This would not matter so much if investors abroad and at home had full confidence in the Nigeria’s monetary authorities. However, what confidence there was has been severely dented by the unexpected suspension of the central bank governor Lamido Sanussi, after the governor alleged large-scale corruption in the state oil company the Nigeria National Petroleum Corporation.
None of this changes the fact that despite some modest depreciation, the Nigerian currency has been fairly stable for at least five years. But in the world of currency trading perceptions can change suddenly. Rising world interest rates, a sudden change for the worse in Nigeria’s national accounts, and a central bank adrift – it could be a perfect storm Nigeria and its currency. And the authorities in Kenya – which itself is about to restate its national accounts – will certainly be watching closely to see whether these pressures start to undermine the naira.
When currencies fall corporate profits fall with them, investors take fright and whole economies start to lose their momentum. This year has seen that begin to happen to several economies that previously looked robust. And the slide may not be over.