Despite generally favourable economic fundamentals, with growth expected to return to nearly pre-crisis levels by 2011, there has been a noticeable disconnect between the performance of emerging-market (EM) currencies such as the South African rand (ZAR) and other frontier African currencies ÔÇô which, in general, have been subject to less appreciation pressure.
In late October, South Africa announced bold FX liberalisation measures aimed at facilitating capital outflows and curbing appreciation pressure on the ZAR.
They included abolishing a 10 percent exit levy on funds over a certain amount taken out of the country by emigrants, and a relaxation of individual offshore investment limits and travel allowances.
Discussions are underway which could allow institutions such as pension funds to remit a greater proportion of their assets under management offshore.
While the efficacy of these measures is debatable amid a flood of capital inflows seeking higher yields and diversification away from developed economies, the measures indicate the extent of recent pressure on the ZAR. In contrast, frontier African FX rates have been spared a comparable level of appreciation pressure.
Trade trends are an explanatory factor
The dominance of trade-related flows over portfolio flows in frontier Africa may help to explain this. In Nigeria, despite rising oil output and a stabilisation of prices, spikes in FX demand have put pressure on the FX reserves. In many middle-income African economies, exports as a share of GDP have yet to return to pre-crisis levels.
Nonetheless, import demand has continued mostly unabated, helped in some cases by counter-cyclical measures. In Botswana, which was hit hard by plummeting global demand for diamonds during the crisis, the trade balance only recently recorded its first surplus since September 2008.
Such negative trade influences partly explain why FX reserves have come under renewed pressure. One success of the post-crisis response was the IMF’s allocation of Special Drawing Rights (SDRs) to a number of countries, boosting their FX reserves in the face of growing external pressure.
But a year on, with African growth back, import demand has also grown. African currencies have stabilised in nominal terms, and because inflation is higher than in other regions, they continue to appreciate in real terms.
But the strong nominal effective exchange rate (NEER) appreciation pressures seen elsewhere have only just begun to selectively impact frontier Africa. There are three key reasons for this.
Holding back African FX
(1) It may be too early in the liquidity cycle for frontier African currencies to benefit strongly. Investors forced to exit smaller illiquid markets during the crisis were negatively impacted by market illiquidity. Although risk appetite has stabilised, frontier African currencies may not benefit immediately, given the still-cautious economic environment characterised by less easy availability of leverage.
(2) Africa’s inflation cycle lags that of the rest of the world. Hit hard by the food and fuel price crisis in 2008, African inflation continued to rise even as growth slowed appreciably.
This largely meant that African central banks did not ease monetary policy significantly until well after the onset of the crisis, and after easing by other central banks. As other monetary authorities started to normalise, many African central banks were still easing. With some exceptions (there is still a significant risk of further easing in South Africa), normalisation of African monetary policy is finally underway.
Nigeria has hiked its policy rate, and Zambia has increased OMOs relative to crisis levels. Domestic yields may yet correct to levels attractive enough to draw in offshore inflows in greater scale.
(3) Although trade with Asia has been growing rapidly, it still lags trade with more traditional partners such as Europe in volume terms. In terms of its share of merchandise trade China punches above its global weight in Africa. But the growth outlook in Europe ÔÇô Africa’s dominant trading partner ÔÇô might have more influence on African FX trends. Moreover, with the exception of the oil producers, Africa’s exports as a share of GDP are typically small, at less than 30 percent.
Given this, even if Asian economies kept growing faster, potentially boosting Africa’s trade performance, it is debatable how much difference this will make to non-export-oriented Africa.
Africa likely to be most accommodative of FX appreciation
The extent to which African FX rates benefit from rising inflows only partly reflects developments in Africa. Global influences matter too, and renewed QE in the US may provide a greater boost to frontier FX inflows.
Interestingly, competitiveness ÔÇô particularly in Africa ÔÇô is not seen as a sole function of FX rates. Factors such as infrastructure and business climate are equally important determinants of
competitiveness. Given weak transmission of traditional monetary policy in Africa, and with growth and inflation fears back, policy makers are likely to be more tolerant of nominal and real currency appreciation in Africa than elsewhere.
Razia Khan is Regional Head of Research, Africa
Standard Chartered Bank, United Kingdom.
