Africa Amidst Currency Wars

As the recent G20 Summit in Seoul failed to achieve concrete measures against the world's trade imbalances, the competitive devaluation of currencies, often dubbed 'currency wars', still threatens global stability and brings new challenges to growth in African countries.

Since the onset of the financial crisis, most leading economies have implemented economic policies that directly or indirectly lowered their exchange rates, with the aim of encouraging exports, reducing unemployment or stimulating domestic demand. Some accuse China, for example, of deliberately external page manipulating the value of its currency, the renminbi, with the objective of keeping prices competitive and fuelling growth in its vast export industry. The US is itself being external page criticized for the recent round of quantitative easing, or QE (i.e. printing money to buy government bonds). The US Federal Reserve external page defended its operations, arguing that the dollar's devaluation was only an indirect effect of QE, while US economic growth is in the interest of the global economy.

Numerous Asian and Latin American economies have suffered the consequences of exchange rate manipulation and expansionary monetary policies and have registered strong appreciations of their currencies. With interest rates next to zero in most developed countries, massive amounts of speculative capital is flowing into these emerging markets, where yields are higher and risks are perceived by investors to be relatively low. The Brazilian real, for example, external page appreciated by 34 percent in the last year alone. Strong appreciations were also registered in several Asian economies, including Thailand, Taiwan and Indonesia. As a result, Brazil and Thailand, among others, decided to limit excessive short-term capital inflows with the imposition ofexternal page capital controls. Unexpectedly, such policies received the external page support of the IMF, which has traditionally opposed all types of capital controls, but now fears the development of a financial bubble in emerging markets.

South Africa: Benefits and drawbacks

In this battle of giants, African countries have limited cards to play and basically no power to compete in currency manipulation. The potential scenarios across Africa differ, however, and depend on both a country's ties to the global financial system and its domestic market structure.

The country that is most exposed to financial imbalances is South Africa - the strongest economy in the region. Domestic bond markets received a record net inflow of over $10 billion in the first nine months of 2010 and have put strong pressure on the rand, South Africa's currency, which reached a three year high against the dollar last month. The strong rand has affected key export industries, especially those related to mining and natural resources, and could provoke a loss of jobs in vital sectors of the economy.

However, the pressure on South African financial markets does not only create losers. If, on the one hand, exports have become less competitive and certain costs of production, such as labor and energy, have become more expensive, some domestic-oriented sectors have recorded gains on the other. Supermarket chains and the retail sector, for example, are gaining from the cheaper price of imports. Manufacturing companies are also benefitting, especially those assembling imported components, because they can rely on lower input costs and can offer more competitive prices.

The government could be a potential winner too. Relatively external page low inflation rates and the cheap prices of imports give the government leeway to make key investments in infrastructure, which could sustain economic growth in the future.

Yet, the situation is complicated by imminent losses suffered by exporters. Unions and domestic business associations in South Africa recently pressed Finance Minister Pravin Gordhan to tackle overvaluation and the resultant loss of competitiveness in exports. The government recently external page released a document which envisions a two-pronged strategy based on the reduction of the real interest rate and a possible new tax on foreign capital inflows.

African 'frontier markets'

South Africa, however, is a unique example in sub-Saharan Africa, and other economies in the region face a different set of challenges. An increasing number of investors are looking at other countries on the continent, in particular the so-called " external page frontier markets" of Kenya, Nigeria and Ghana. These countries have been growing over the past ten years at sustained levels, but are only partially integrated in the global financial system.

Unlike in other emerging markets, currencies in African frontier economies have not appreciated consistently over the past two years (see external page chart). With the exception of southern African countries, some of which are pegged to the rand (Namibia, Lesotho and Swaziland), and the external page Franc Zone where currencies are pegged to the Euro, currencies on the continent have tended to remain low. The situation is set to change in the future. As interest rates are relatively high in most African countries, and numerous reports predict strong growth on the continent, international investors have already started seeking external page opportunities in African bond markets. This will probably increase the financial inflows in the future with a consequent impact on the value of currencies.

Some experts see this scenario as a external page threat to development, resembling the path that led to the Asian financial crisis in 1997, when speculative capital triggered a boom and bust cycle that brought several countries to the edge of collapse. They argue that African governments should follow the examples of Brazil, Thailand and (soon) South Africa and raise barriers against short-term capital inflows. The problem is also that currency appreciation will come at the expense of key export markets, in particular the booming horticultural industry in East Africa and agricultural commodities exporters in West Africa.

Remittances could be another major 'victim'. external page Statistics from the Central Bank of Kenya show that their total value up to September 2010 stood at $461 million -their second highest in the past decade. In Nigeria the World Bank external page Migration and Remittances Factbook 2011 estimated an inflow of $10 billion in 2010, making Nigeria the 10th largest remittance-receiving country in the world.

On the other hand, an increasing number of experts see higher capital inflows as an external page opportunity for growth. If managed properly, they can contribute to the inclusion of African countries in the global financial system. According to this view, an increased interest by international investors will bring both short-term speculative capital, which will increase the vulnerability of African markets, as well as much needed foreign direct investment (FDI) which would promote long-term growth.

The corollary of this increasingly tough financial environment is that African economies could register an expansion of domestic demand and push intra-regional trade further. As international exports decline due to currency appreciation, regional markets will become the main target for domestic producers. In this context, the idea of the "regionalization of Africa" will cease to be only a postcolonial dream, becoming instead a necessity for sustained growth.

Governments have already expressed their interest in regionalism as an overall approach to economic and other challenges, and some important steps have recently been taken. What remains to be seen is whether there is sufficient political will and capacity on the continent to transform words into actual investments.