Policymakers snookered as African currencies tank against US dollar

BY BEN EGUZOZIE IN PORT HARCOURT

• Nigerian naira worst-hit with 70%‭ ‬rate fall
• Pressure mounting on exchange rates

African currencies have lost ground against the US dollar year-to-date, thereby driving inflation in the import-reliant continent. Policymakers across the continent are left with limited options to arrest the decline as a result of depleting dollar reserves, according to a report adapted from DW.

As US interest rate hikes make the dollar more attractive to investors, sub-Saharan Africa currencies have been weakening. The downward spiral of the African currencies against the US dollar this year has been spelling trouble for citizens and businesses alike.

The Nigerian naira is, so far, the biggest loser, falling more than 70 percent against the dollar this year, chiefly after the Central Bank of Nigeria (CBN) removed trading restrictions on the official currency market. In Lagos, the country’s financial capital, money changers count wads of the Nigerian naira currency at bureaux de change (BDC) to buy the dollar, which has been exchanging about N750/$.

Joseph Obeng, president of the Ghana Union of Traders Association (GUTA), said, “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.”

Key events have been dragging down the African currencies: hikes in interest rate in the US, which is pushing away investors in pursuit of higher returns toward US assets; and weak demand for African exports amidst global recession worries.

Across the continent, the report said 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.

Typically, Nigerians have been the worst-hit as inflation hit a record 22.04 percent, the third consecutive increase in 2023. The recent removal of subsidies on petroleum products by the new president, Bola Tinubu has driven food inflation to surge to 24.45 percent, the highest ever.

When currencies weaken against the greenback, imports become expensive, as they are mostly denominated in US dollars. For Obeng, “we are unable to make profits since our customers no longer have the purchasing power to patronise our businesses”.

Reasons African currencies lose value

A combination of both internal and external problems has been behind the unceasing decline in African currencies. Although there are no easy answers, but major among the reasons is that African economies have been unable to recuperate fully from the economic disruptions triggered by the COVID-19 pandemic.

Stephen Akpakwu, head of sovereign advisory at Crossboundary Advisory, is quoted by DW as saying, “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,” he added.

Another reason is that many sub-Saharan African countries depend on a slim range of commodities for foreign exchange. Mainly, they export raw agricultural products, only to buy back processed finished products from the raw agric produce. Additionally, when global demand for those [mainly agric] goods falls, the value of the African countries’ currencies drops due to a drop in foreign income.

In particular, there has been lower demand for African exports arising from the global economic slowdown due to the Russian war in Ukraine. This has extremely hurt foreign exchange earnings and pulled down African local currencies. The Russian–Ukraine war has also partly driven up import costs for food and fuel, further depleting the foreign exchange reserves in Africa.

Also, fiscal deficits, which is the shortfall in a government’s total income compared with its expenditure, have been partly blamed for causing higher demand for dollars. The International Monetary Fund (IMF) said about half of the countries in sub-Saharan Africa had deficits exceeding 5 percent of gross domestic product (GDP) last year, putting pressure on their exchange rates.

Nigeria, with its budget deficit rising 370 percent to N47 trillion under former president, Muhammadu Buhari, the country’s currency, the Naira is the biggest loser, falling more than 70 percent against the dollar this year, mainly after the Nigerian central bank (CBN) removed trading restrictions on the official currency market.

Consequences for continent’s economies

More than two-thirds of imports in most sub-Saharan African countries are priced in US dollars. Hence, the region is highly sensitive to a strengthening dollar. The IMF said in a blog in May (this year) that a one 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 sub-Saharan Africa.

“There is also evidence that inflationary pressures do not come down quickly when local currencies strengthen against the US dollar,” the IMF said.

With 60 percent of external debt in US dollars in sub-Saharan African countries, declining currencies are making it more costly to service those loans. Nigeria, with a loan portfolio of N46.25 trillion or $103.11 billion as of December last year, is a study in high debt servicing rate. The country’s debt servicing bill went up by 115 percent to N3.36 trillion in 2022, according to data from the Nigerian Debt Management Office (DMO). The World Bank said Nigeria used 96.3 percent of its revenue earned in 2022 to service debts. The KPMG, a consulting firm, warned in May that Nigeria could be heading to using 100 percent of its revenue to service debts down this year.

Akpakwu concedes, “you have a real issue with debt. 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”.

Governments addressing the situation?

Different governments in SSA 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 prioritising 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.