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Navigating Trends in Emerging-Market African Currencies

Currency volatility presents challenges both for treasurers working in Africa and central banks

Currency volatility presents challenges both for treasurers working in Africa and for the central banks throughout the continent. David Bee, Head of Global Markets at Crown Agents Bank, explores some of the recent trends in the African foreign exchange landscape and explains how volatility might be managed.

It goes without saying that any organisation working in Africa – whether financial institution, payment provider, government aid agency or NGO – needs access to local currencies. Yet these are often hard for treasurers to find on global markets. And as if availability was not enough of an obstacle, they must deal with the persistent challenge of price volatility.

For the central bankers working to preserve fiscal stability across the continent, volatility presents further challenges.

Higher prices for major-traded (G10) currencies can make imports more expensive, push up inflation and risk debt, while defending local exchange rates potentially impact reserves.

With the help of the right global transaction banking partnerships, however, both foreign treasurers and African central banks can weather the foreign exchange environment.

The Need for Illiquid Currencies

For those organisations doing business with Africa, the ability to source emerging- and frontier-market currencies – from the Ethiopian birr to the Zambian kwacha – is essential. Perhaps most obviously, it allows OECD-based banks to facilitate their clients’ trade across Africa, and unlock new growth potential in markets that are rapidly rising in importance.

Accessing foreign exchange also underpins the work of those specialist payment providers – among them many fintechs – that channel cross-border remittance flows from the developed world to home countries in Africa. These providers represent a crucial source of income for the families of working diaspora populations.

The need for emerging-market currencies is by no means limited to the financial sector. Government aid agencies channelling development funds from the OECD require local currencies in what may be challenging and remote jurisdictions – as do NGOs responding to environmental or humanitarian crises. An international charity, for instance, may collect its donations in euros, krone or sterling, but operating on the ground in Africa could mean sourcing Ugandan shillings or Rwandan francs with which to fund its grassroots projects, pay local staff, and maintain ongoing operations in far-flung locations.

The problem is that such currencies can be relatively illiquid. Often rarely traded on global markets, OECD-based treasurers can struggle to source them from their banks. Yet find them they must – reliably, on time, and at competitive prices.

Volatility: A Challenge for Treasurers

If it is hard to find these local currencies, it can be harder still for treasurers to find them at stable prices. Recent years have seen increased movement in some African currencies.

One example is Mozambique: Having reached an all-time high against the dollar in October 2016, the metical retreated over 30% by the end of that year – before rebounding by another 20% to become one of the best currencies of 2017.

In Sierra Leone, meanwhile, the Leone weakened by a considerable 27% over 2016. But its value climbed significantly throughout 2017, almost doubling in value against the dollar last year, and has reached record highs this April.

The Zambian kwacha has also experienced a wide trading range over the past few years. In 2015 it depreciated by over 40%, it then rallied by nearly a fifth in the first half of 2016 and a further 13% in the second – to become among the world’s best-performing currencies of that year. 2017 and 2018 so far have seen only a small degree of stabilisation.

Further Headaches for Central Bankers

Currency volatility also presents challenges for African central banks, for several reasons. First, many emerging and frontier economies in Africa remain highly dependent on reliable supplies of G10 currencies – above all, US dollars, but increasingly Chinese yuan – to facilitate imports of capital goods, fuel and machinery. Demand for foreign exchange will only rise as Africa’s economies continue their development and invest in ambitious new infrastructure projects. Countries such as Ethiopia and Kenya, for instance, have spent much of their foreign exchange reserves in recent years on high-cost infrastructure developments, from dam and power distribution projects to road, rail and port infrastructure. By making imports more expensive, price volatility represents a threat to the ongoing viability of such projects.

Second, weak local exchange rates contribute to rising consumer prices. By April of last year, inflation in Kenya, for example, had reached a five-year high of 11.7 per cent. Here, the shilling had depreciated by 15 per cent against the dollar from 2014 to 2017 – and even this was modest compared to many other sub-Saharan currencies. (Aided by currency stabilisation since the start of this year, this has now been tamed, to around 4.2 per cent as of March).

Third, currency volatility can increase fiscal pressures. Some countries – Ethiopia and Zambia among them – have reduced their foreign exchange reserves in recent years by actively intervening in their local currencies. With sovereign bond issues largely priced in foreign currencies, any subsequent depreciation in local African currencies makes servicing obligations more expensive. This problem has been particularly pronounced for those governments that took advantage of relatively cheap financing in the years just after the global financial crisis. Having issued foreign currency-denominated bonds, refinancing may be more expensive given weaker local currencies once maturities approach.

What can be done?

Given the volatile landscape, some corporate treasurers may choose to retreat to a collection of “safe havens”. Several developing economies in Africa have certainly enjoyed relative currency stability in recent years – chief among them the countries of the African Financial Community (CFA) zone (Benin, Burkina Faso, Cameroon, Central African Republic, Chad, Republic of the Congo, Equatorial Guinea, Gabon, Guinea-Bissau, Ivory Coast, Mali, Niger, Senegal and Togo). Such stability is thanks in no small part to the fact that the two currencies in use in the region – the Central African franc and the West African franc – are both pegged to the euro. This smooths the flow of foreign (especially European) trade, reassures investors, and reduces inflation.

Of course, not all treasurers can take the safe-haven route. For NGOs, development agencies and remittance firms – whose work takes them to some of the most challenging jurisdictions – retreating from certain markets is just not an option.

Treasurers at these organisations must therefore look for the right transaction banking partners. Such partners must be experienced with, and committed to, emerging markets in Africa. They must be able to help their clients adapt to the volatile foreign exchange environment with agile, modern currency trading technologies – which is why at Crown Agents Bank we’ve recently launched a new online platform, EMpowerFX, for that very purpose. And they must also have strong relationships with local African financial institutions for access to competitive rates for local currencies. These relationships can, in turn, ensure that central and local commercial banks on the ground are well supplied with G10 currencies.

Crucially, these transaction banking partners need to focus on their due diligence. The withdrawal by many large global banks from smaller or challenging jurisdictions in Africa – largely in the face of mounting compliance pressures – has prompted the loss of some foreign exchange services. That is why at Crown Agents Bank, for instance, we invest in the strict regulatory compliance controls necessary to preserve the vital flow of foreign exchange between Africa and global money centres.

Like many emerging currencies around the world, volatility in Africa is unlikely to end any time soon – least of all in emerging and frontier markets. But with the right partners, both OECD-based treasurers and African central banks can continue to source the foreign exchange they need.

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