How the dollar affects Africa

By MOIN SIDDIQI

The US dollar is the benchmark currency across Anglophone Africa and most of the region’s major currencies underwent a steady depreciation against the greenback during the first-quarter of 2001. The obvious reason is the strength of the dollar, despite the ongoing recessionary fears and plummeting US stock markets.

The movements of African exchange rates are influenced by a set of variables, similar to those governing the developed world’s currencies. The main factors are: inflows and outflows of foreign capital (private/official), macro-economic fundamentals (inflation and growth differentials with major trading partners), the overall state of public finances, pace of economic reforms (market liberalisation and deregulation), commodity prices - that in turn depend on global economy and international trade, as well as investor’s confidence - which is mainly influenced by good governance and sustained political-socio stability.

Double whammy

Most African currencies are commodity-based and therefore remain vulnerable to terms of trade losses, i.e. weak export prices amid escalating import costs. Last year, major producers of non-oil commodities had suffered a double whammy - plunging prices for their exports and soaring fuel import costs.

Among the countries most severely hit was Ghana, where low cocoa and gold prices were blamed for the cedi’s steep 101% depreciation versus the dollar - the largest fall in Africa. Coté d’Ivoire, which earns 60% of its foreign exchange from cocoa and coffee, Uganda (50% coffee), Mali (gold and cotton), and Chad, Burkina Faso and Benin (heavily reliant on cotton) were also affected by poor external positions in 2000.

The outlook for Africa’s external trade in the near future is not very promising. Total exports in dollar-terms surged 26% in 2000, largely underpinned by higher oil prices, but volumes rose modestly at 6%, according to the International Monetary Fund. However, with the global economy slowing down, the IMF projects export growth of only 2%, while imports in dollar-terms are forecast to increase by 8% in 2001. Consequently, the continent’s terms of trade may weaken by about 5% and therefore the trade-balance is projected to dip into a deficit of $5.4bn, compared to a surplus of $4.6bn in 2000.

However, debt relief and other official flows should cushion the impact of trade deficits upon countries’ overall external accounts.

Commodity prices to stay low

Between 75-80% of Africa’s merchandise trade comprises primary commodities (oil/gas, precious and base metals and softs). According to the World Bank’s forecasts, cocoa prices which dropped 47% in 2000 to average 90cents/kg, should rise modestly to 95c/kg, cotton rising 8% to 138c/lbs and coffee prices having fallen by 40-50% since 1998, will also recover slightly. But the IMF warns that African non-fuel commodity prices this year would still be 20% below their 1995 levels.

Whereas, the demand and prices for industrial raw materials (copper, cobalt, aluminium, zinc and nickel) are being affected by lower production in America and Japan (which combined account for 40% of world’s gross domestic product). However, the outlook for platinum group metals (South Africa’s largest export earner) is more positive compared to gold. The latter will probably trade below $300oz in 2001-02.

Crude oil prices are expected to remain quite firm averaging $23-$25 a barrel.

Despite the fall in commodity prices, sub-Saharan Africa’s economic situation remain basically good, if not buoyant. The World Bank projects regional GDP growth of 3.7% and inflation rate slowing down to 8.5% from 13% in 2000. Nevertheless, growth and inflation forecasts in 2001 compare less favourably with other developing regions of Asia and South America.

Finally, net capital flows to Africa will probably decline to about $8bn from $9bn in 2000, according to the IMF.

Therefore, the combination of sluggish export growth, expectations of painfully slow recovery in prices of African softs (cocoa and coffee), and SSA’s inflation rate still above the developing world’s average of 5.2%, as well as declining capital flows, point to a further round of steady depreciation for regional currencies this year.

The bulk of Africa’s primary commodities are priced in US dollars. This means that a stronger greenback, in effect, boosts SSA’s export revenues in dollar-terms and buys more imported goods, principally from the European Union countries and South East Asia. On other hand, Africa’s foreign exchange earnings have suffered during periods of the dollar’s weakness - as in 1994-5.

Speculation hits rand, again

But a nasty devaluation, like recently in Turkey, raises the costs of servicing external loans, i.e. requiring more local currency for repaying debts in hard-currencies. It also undermines business confidence by increasing risk-premiums for foreign investors.

The beleaguered rand has again sustained heavy selling as speculators dragged it to record lows of over R8:$1 in early April. Last year, the rand had averaged 6.9 to the dollar and 10.5 versus sterling. A sensible explanation for its latest plunge is speculative short-selling. This term means selling a currency you don’t own on futures markets in order to make a profit by buying later at a reduced price.

The SA Reserve Bank lacks higher forex reserves for defending its currency from speculative attacks and does not wish to harm growth prospects by raising official repo rate (currently 12%). Only a stable rand can facilitate lower interest rates, thereby stimulating consumer and business spending and investment.

There is some evidence of negative sentiment towards SA and a tendency by markets to discount any favourable news on the economic and corporate fronts. There is little doubt that on fundamentals the rand is undervalued. In fact, Moody’s Investors Service is expected to upgrade SA’s (Baa3) investment-grade rating in light of improving economic indicators for 2001-02 - a real GDP growth of 3-4%, inflation dipping to 4-6%, manageable external debt ($39bn) and a current account deficit of $1.7bn. Coupled with prudent fiscal and monetary policies, on fundamentals, the rand should rebound to between R7.4-R7.8:$1 range. But forex market operations are now rarely governed by economic rationalisation.

Weak rand affects SADC

It seems that only substantial foreign investment (linked to privatisations) can improve the rand’s fortunes. The main attraction will be 20-30% initial public offering of Telkom - worth R25bn. Other divestments could increase total privatisation receipts to R38bn this year.

The rand’s on going weakness has affected member countries of the Southern African Customs Union. The currencies of Swaziland, Lesotho and Namibia are 100% linked to the rand. Although Botswana’s pula - Africa’s strongest currency underpinned by a vibrant economy and substantial foreign assets including over $6bn in forex reserves - is tied to a basket of currencies, it is dominated by a 60% rand weighting. The pula tracks the rand, in order to maintain the competitiveness of its non-diamonds exports.

Zimbabwe is gripped by a severe external payments crisis and annual export earnings, mainly from tobacco sales, are estimated to have dropped to $2bn, down from a peak of over $3.3bn in 1996/97. The government’s fixed exchange rate policy requires a continuation of stringent capital controls. According to the IMF’s, the Zim dollar is currently overvalued by 56% amid surging inflation and negative GDP growth. The acute shortage of forex reserves has encouraged a thriving parallel market, operating at close to double the official rate of Zim$55:$1. Sooner or later, devaluation will be necessary. In the free market, too many cheap Zim dollars are chasing too few expensive hard currencies, but the government has so far declined the devaluation option fearing spiralling imported-inflation.

The Zambian Kwacha should derive some support from increasing copper production and exports after last year’s privatisations. Similarly, new exports from the Mozal aluminium plant and inward capital flows are also supportive of Mozambique’s metical. In essence, all southern African currencies remain highly vulnerable to the politico-economic situation in neighbouring Zimbabwe.

The Tanzanian shilling last year was East Africa’s most resilient currency, thanks to buoyant GDP growth (5.2%) and increasing exports. It’s positive outlook is underpinned by expectations of more foreign investments into gold mining and an improving economy.

Sentiment towards the Kenyan shilling is weakening, because of stalled structural reforms - especially the slow pace of privatisation and lack of funding from the IMF and the World Bank. Standard Chartered Bank expects a paltry GDP growth of 0.5% in fiscal 2000-01 (ending 30 June).

Oil will support Naira

In Nigeria, continuing robust export earnings from crude oil and liquefied natural gas will support the naira by ensuring a higher trade surplus and substantial forex reserves, which rose to $9.898bn at end of 2001.

The Bank of Ghana has succeeded in stabilising the cedi by implementing measures like increasing Treasury Bill rates and raising commercial banks’ reserve money requirements to 9% and limiting large over-the-counter cash withdrawals. Restoring macro-economic stability and renewed capital flows (mostly aid-related) will help the cedi.

The CFA franc is pegged to the euro at a fixed parity (655.957) via the French franc, but the embattled euro has been dragging the FF/CFA franc downward against the world’s major currencies over the past year. Fortunately for exporters, a weakening euro is beneficial because it boosts the value of dollar-based earnings in CFA franc terms.

The future prospects for regional currencies depend largely on the greenback’s performance. Global financial instabilities are encouraging safe-haven flows into the dollar, thus weakening African currencies. Africa’s commodity-based currencies will remain vulnerable to external shocks, unless far greater export-diversification achieved in the coming years.

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