Exchange rate pressures are difficult to resist reality that face Africa. The signal of currency movements is under the careful watch of all economic agents, nonetheless particular interest is fixed on the United States dollar. But why the dollar and what are the pressures it exerts on the African region?

The international monetary system has evolved over the years from having currencies fixed against gold to having them fixed against the dollar. The dollar has garnered the reputation as the dominant currency for international trade invoicing and financing and many exchange regimes anchor their home currency to the dollar. Half of cross border loans and international debt securities are dominated in dollars, and central banks and governments hold the dollar as their reserve currency. Therefore, the dollar carries the image as a stable currency and the world’s safest asset. However, a survey by IMF’s Currency Composition of Official Foreign Exchange Reserves (COFER) indicates a falling trend in the dollar’s share of global foreign reserve holdings declining from 62% to 59% by the fourth quarter of 2020 and ended 2022 with 58% share. Nonetheless, the dollar’s foothold in international trade and financing remains dominant.

Dollar appetite in SSA

IMF reports that a total of 84% of exports, 67% of imports and 60% of external debt are priced in dollars for the average Sub-Saharan African country. The debt stock of non-pegged countries comprises 66% of external debt and 99% of Eurobonds in US dollars, compared to 50% and 45%, respectively in pegged countries. Evidently, the use of the dollar as a medium of exchange and store of value is very much present in SSA. This suggests that any form of dollar appreciation sends shivers down the spine of almost all currencies within the Sub-Saharan Africa (SSA) region, particularly in non-pegged countries. Non-pegged countries in the region do not have their exchange fixed to a specific currency, so they have the flexibility and independence to regulate policy rates, unlike pegged countries where their exchange rates are fixed mostly to the euro or the South African rand, and thus must align their monetary policy with the peg country.

In 2022, official exchange rate depreciation to the dollar in non- pegged countries averaged 7%, with some cases exceeding 20% and at times reaching 90%, while that of pegged countries reached a peak of 20% in September 2022.

The exchange rate pass-through effects

The pressure from currency depreciation in Africa is displayed in higher inflation, larger debt, and a weaker trade balance. The region’s appetite for imports and external borrowing, which are largely dollarized, increases the exchange rate burden. In SSA, the exchange rate pass-through to inflation averages 1 to 0.22, i.e, a 1% depreciation against the dollar leads to a 0.22% increase in Inflation within the first year. This is higher than the (0.18%) in Latin America and (0.15%) in emerging Asia. The size of the depreciation also matters. For example, the effect of a modest depreciation will be felt mostly within the first year, but with a larger depreciation, inflation increase will be felt well into the second year. Moreover, incidents of depreciation pass-through to inflation, according to the IMF, hit about eight times stronger than what is gained when the local currencies appreciate against the dollar.

About 40% of the region’s public debt is external and since the outbreak of COVID-19 pandemic, exchange rate depreciation has increased public debt by an average of 10% as at the end of 2022. The significant exchange rate depreciation exacerbates financing conditions by increasing external debt service burden. Also, trade balance deterioration is associated with currency depreciation. Considering the structural barriers in SSA, such as the weak business environment and primary nature of exports, exporters require time to adjust production to respond to changes in relative prices.  The region therefore tends to be relatively more exposed to price shocks. An additional manifestation is in the running down of central banks’ reserves due to import financing and foreign debt repayment because foreign exchange inflows slow down. By the end of 2022, 40% of non-pegged countries had reserves less than three months of imports. An IMF index which combines currency depreciation against reserve depletion showed that exchange rate pressures, on average, were at a six- year peak in 2022, and were higher in non-resource intensive countries and pegged regimes. Pegged regimes suffered less in relation to the value of the dollar but lost considerable international reserve over the period.

Responding appropriately to the pressures.

Indeed, policy responses succeed when they focus on drivers of exchange rate movements and on signs of market disruptions. Exchange rate pressures are usually driven by both global and domestic factors. In 2022, a combination of tightened financial conditions as world interest rates hiked, and economic slowdown in major economies led to decreased foreign exchange inflows into the SSA region, weakening demand for exports while import costs pushed up due to higher oil and food prices. On the domestic side, fiscal deficits contributed to the exchange rate pressures, and the larger the deficit comes higher exchange rate pressures. In 2022, about half of the SSA region had deficits exceeding 5% of GDP.

Measures employed to resist exchange pressures have included the Central banks’ intervention in the forex market, raising interest rates and administrative measures applied to control foreign exchange flow which included some conventional measures like multiple currency practices, foreign exchange rationing, price control either through moral persuasion or punitive measures, banning foreign currency transactions for local businesses, and with also some unconventional administrative measures such as buying oil with gold.

However, closely following the central bank’s intervention in foreign exchange trading is the depletion of national foreign reserves. In 2022, the average depletion of reserves in SSA due to foreign exchange intervention was twice higher than in other emerging market and developing economies.

Critiquing views on policy responses have pointed out that foreign exchange intervention should not be a substitute for macroeconomic policies, and therefore should be a temporary measure if employed. Keeping public debt at a sustainable level and cutting down expenditures that directly or indirectly affect imports is considered vital. Also, the use of administrative measures may not mitigate against the adverse impact, but it can lead to market twists and misallocation of resources and create opportunities for corruption.

Could the appropriate response therefore be to allow exchange rate to adjust and use monetary policy as a tool to keep inflation in check, stem outflows and attract capital from abroad?

A unified front?

Suffice it to say that these exchange rate realities and response mechanics beckons countries to actively support their currencies. Country groups like BRICS (Brazil, Russia, India, China, and South Africa) are floating the idea of a common currency with initial steps of settling transactions in national currencies rather than the US dollar. The call for an African Monetary Union with a unified currency (Afro or Afriq) by 2025, still sits at the table. With two existing regional currency unions; the West African CFA franc, and the Central African CFA franc, as well as the Common Monetary Area that links several South African countries based on the South Africa Rand, further integration for more regional unions like the ECOWAS eco which remained pending for the last three decades, ought to be encouraged.

It is the belief that the implementation of a common African currency and through the African Continental Free Trade Area (AfCTA) platform, a paradigm shift could be underway for a successful de-dollarization. One of the committed supporters of AfCFTA, Afrieximbank launched a Pan-African Payment and Settlement System (PAPSS) which has been adopted by the African Union (AU) as the payment and settlement platform for the implementation of AfCFTA, allowing regional trade in Africa to be done through local currencies.  What happens if all African countries trade without the US dollar and will Africa pass the unity test for an eventual unified currency?