African Economies Impacted by Dollar Dynamics

In recent months, numerous African currencies have faced significant devaluation against the US dollar, leading to an outflow of dollars from these countries. As a result, central bank foreign exchange reserves have come under severe pressure, while local currencies continue to plunge, creating a backdrop of rising inflation and economic instability. In some regions, unrest has even sparked protests against governments struggling to cope with these financial challenges. Consequently, many African nations are exploring alternative solutions to mitigate the impact of a strengthening dollar.

Since March 2022, the Federal Reserve has embarked on a swift cycle of interest rate increases. Currently, the target range for the US federal funds rate stands between 5% and 5.25%. With the recent release of Consumer Price Index (CPI) data, market analysts anticipate that this aggressive tightening cycle, the most extreme in decades, may be nearing its conclusion.

However, this increase in interest rates has raised the cost of obtaining dollars in the market and heightened the fiscal burden of dollar-denominated debt. The strong dollar continues to disrupt emerging market economies, with few signs of it abating in the near term.

Advertisement

Since the beginning of this year, several African currencies, including the Kenyan shilling, Nigerian naira, Central African franc, and South African rand, have consistently weakened against the dollar. Other emerging market currencies, such as the Argentine peso and Indian rupee, have also seen dramatic declines.

The Dilemma

In Africa, the US dollar has often been considered a “hard currency” in comparison to the volatile local currencies. Importers and foreign investors typically prefer dollars for transactions. However, this traditional reliance is undergoing fundamental changes.

Recently, it has become increasingly evident that as local currencies continue to devalue against the dollar, the cost of importing goods and remitting payments to foreign investors has surged. Consequently, major investment destinations in Africa, such as Egypt, Nigeria, and Kenya, have witnessed significant dollar outflows, straining both their central bank reserves and local currency values while intensifying inflationary pressures and leading to record currency depreciation. Protests and civil unrest have emerged in some countries as citizens react to these dire economic conditions.

Since March of last year, the Egyptian pound has lost more than 50% of its value, with an official exchange rate currently estimated at 1:31 against the dollar. Meanwhile, following the Central Bank of Nigeria’s decision to unify multiple exchange rates and eliminate the dollar peg on June 14, the naira has plummeted by more than a third in value. The International Monetary Fund (IMF) reported in May that the average depreciation rate of currencies in sub-Saharan Africa has been approximately 8% since January 2022, with some, like the Ghanaian cedi and Sierra Leonean leone, facing depreciations of over 45%.

This increase in import prices, when calculated in local currencies, has led to a pronounced increase in living costs, further exacerbating inflationary trends. According to Forbes, the inflation rate across the African continents has surged to an alarming 30% as local currencies depreciate.

Christopher Adam, a professor of development economics at Oxford University, asserts that the crisis facing African nations is rooted in disruptions to supply chains caused by the COVID-19 pandemic and the subsequent global economic downturn. These factors have led to a dramatic decline in prices for key export products and a stagnation of the tourism industry, which has been a significant source of dollar inflows.

Taking Nigeria, Africa's largest economy, as a case study: According to the Central Bank of Nigeria, the country recorded an international balance of payments deficit of $840 million in 2022, in stark contrast to a surplus of $3.75 billion the previous year. These figures reflect the broader economic context, where Nigeria, a major oil exporter, has experienced financial strain despite benefiting from rising international crude oil prices.

Adam further points out that African countries now find themselves in a dilemma: “If nations seek to implement a fixed exchange rate, a (dollar) shortage will become apparent. Conversely, if the exchange rate is allowed to float freely, it will likely lead to substantial depreciation of local currencies.”

Risk of Default

The IMF report indicated that approximately 40% of public debt in sub-Saharan Africa comprises foreign debt, with over 60% of that debt denominated in dollars. As the value of local currencies continues to decline, repaying dollar debt becomes increasingly expensive. Consequently, many countries are facing imminent debt crises.

IMF President Kristalina Georgieva acknowledged during a visit to Nairobi in May that African nations are encountering severe challenges, stating that 19 of the 35 countries in sub-Saharan Africa are “in or near debt distress.” Kenya has also been identified by the IMF as a high-risk country due to its debt troubles.

The Institute of Economic Affairs in Nairobi reported that due to the depreciation of the Kenyan shilling, the dollar-denominated debt repayment cost rose by 25% compared to the beginning of 2021.

President William Ruto of Kenya corroborated these concerns. On July 12, while explaining a contentious new tax policy, he stated that rising interest rates and a strengthening dollar have made financing options more expensive, hence raising the risk premiums for African nations. “Kenya spends approximately $10 billion annually on debt repayment. There is a priority to repay the $2 billion Eurobond maturing next year. The ratio of debt repayment costs to the country's total revenue has surged from 59.5% in the 2021-2022 fiscal year to 63.5% in the 2023-2024 fiscal year.”

In Zimbabwe, the African Development Bank reports that the national debt has ballooned to $17.5 billion. This amount comprises $14.04 billion owed to international creditors and $3 billion in domestic debt.

The United Nations report on July 12 emphasized that, “in Africa, interest payments far exceed expenditures on education or healthcare.” It revealed that nearly 3.3 billion people live in countries where debt servicing takes precedence over education or healthcare financing. “Countries are caught in an impossible dilemma: repay debt or serve their people.”

UN Secretary-General António Guterres highlighted during a press conference on the same day that the average borrowing costs for African nations are four times that of the United States and eight times that of the wealthiest European economies.

Parting Ways with the Dollar?

In light of the prevailing challenges posed by the dollar, several countries are actively seeking alternatives.

Reports from local African media suggest that Kenyan President Ruto has advocated for the adoption of a Pan-African Payment and Settlement System (PAPSS) among African leaders to foster intra-continental trade and diminish the dollar’s status as the world’s primary reserve currency. The PAPSS initiative is supported by the African Union and various central banks across Africa, developed in collaboration with the African Export-Import Bank and the Secretariat of the African Continental Free Trade Area.

“Due to currency disparities, payments for goods and services across borders have become exceedingly challenging. In these transactions, we are all affected by the dollar’s dominance,” Ruto stated, asserting, “We need not seek after the dollar. Our businessmen will focus on the transportation of goods and services, leaving the complex task of currency settlement to the African Export-Import Bank.”

Additionally, former Zimbabwean Minister of Information and Communication Technology Supa Mandiwanzira expressed in an interview with CCTV News that purchasing fertilizers and seeds in dollars imposes significant risks on the nation. He advocated for the use of local currencies to enhance their competitiveness, proposing that Zimbabwe diversify its reserve currency strategies in light of the trend towards “de-dollarization.”

South Africa, too, looks to the BRICS mechanism for encouragement. President Cyril Ramaphosa has indicated that the issue of currency will be a key agenda item at the forthcoming BRICS summit in August.

“This can be seen as a manifestation of de-dollarization,” financial commentator Zhang Xuefeng noted, suggesting that the sustained weakening of African currencies against the dollar and calls to abandon the dollar in trade transactions reflect a growing desire among these nations to reduce their dependence on the dollar and mitigate risks associated with fluctuations in the dollar’s value.

Zheng Lei, chief economist at Samoya Cloud Technology Group, pointed out that many countries calling for the adoption of substitute currencies or local currency settlements may represent a persistent long-term trend. Some nations aim to diminish their reliance on the dollar, adopting other currencies for transactions or promoting their own currencies as viable alternatives for international settlements in order to enhance sovereignty and economic standing.

Nevertheless, the movement towards “de-dollarization” does not equate to the decline of the dollar’s hegemony. The dollar’s prevailing role is not likely to change swiftly. Chen Jia, an independent international strategy researcher, argued that while the momentum for de-dollarization is accelerating, it is still far from achieving a full substitution for the dollar.

Zheng Lei also emphasized that the dollar's dominance is underpinned by the United States' position as the world’s largest economy and its leading trade nation, along with the stability of its government and financial system. Moreover, the dollar's extensive use in international trade settlements, international reserve assets, and international debt continues to fortify its stronghold. However, as the global economic landscape evolves and other nations rise in prominence, challenges and pressures may arise that could erode the dollar’s standing. “For the foreseeable future, the dollar will remain a central currency for trade settlements and reserves, although its proportion in international trade settlements may decline,” Zheng remarked.