RegionsAfricaCurrency illiquidity: Navigating Africa’s Markets

Currency illiquidity: Navigating Africa’s Markets

Investment into Africa shows no signs of abating. Yet with 44 currencies serving the region – many of which are rarely traded on the global markets – currency illiquidity remains the biggest obstacle for both the region’s treasurers and for investors looking to engage in Africa. This – combined with reduced access to cross-border payments infrastructure – is limiting Africa’s intra-regional trade, which is underweight despite its great potential to drive economic development on the continent. David Bee, Head of Global Markets at Crown Agents Bank, considers the options available to overcome these final barriers to growth.

The slump in commodity prices (particularly oil) hit Africa’s nations hard in 2013 – laying bare the region’s vulnerability to external economic shocks. While clearly rich in natural resources, most African economies were undiversified, resulting in their exports being heavily weighted towards raw materials. But fast forward to 2019, and countries in the region have become substantially more economically sophisticated. Many have begun to diversify into the manufacturing of secondary goods or are attracting investment in that direction. For example, in 2018 a global car company signed a contract to open an assembly plant in Ghana and is now also expanding automotive operations into Nigeria. Aside from bringing additional employment into the local communities, such diversification has the added benefit of fortifying African economies against the potential for future commodity market volatility.

Foreign direct investment continues to flood in with China still leading the pack, as well as retaining its status as the largest individual trading partner with countries in the region. Asia and Latin America have also become important markets for African commodities and importers of finished goods, and capital markets are continuing to develop with more portfolio money being invested in equity and debt markets.

Demand exceeds supply

Yet currency illiquidity can still present a challenge to development and/or execution, and even the hike in demand has yet to stimulate sufficient cross-border remittance capabilities. Foreign participation brings with it a collateral need to source African currencies quickly and viably so as to finance on-the-ground activities, engage with foreign trading partners and deliver humanitarian aid during times of crisis. But, with 44 currencies serving the region, many of which are rarely traded on the global markets, illiquidity of local tender is understandably common.

The de-risking trend seen in the post-financial crisis era in the international markets only made matters worse. Many international correspondent banks withdrew their capacity from African markets – leading to a backlog of trade payment obligations and lost investment opportunities. But the adverse impact on economic development is not the only consequence of currency concerns – it has direct and dire human impacts too. For deliverance of aid, where the need is immediate and acute, the inability to viably source local tender has desperate ramifications within communities – money cannot always reach its destination in a timely manner and too much is lost to conversion or distribution costs.

African currencies are governed by a complex mix of domestic politics and global market conditions, but no solution is perfect. And despite careful attempts to balance social needs and inflation in their formulation of monetary policy, countries across the region are also still stressed by currency volatility. The Zambian kwacha, for example, depreciated by approximately 42% against the US dollar in 2015, and has since rebounded, and the Angolan kwanza fell by more than 30% following the partial liberalisation of the exchange rate regime at the beginning of 2018.

Trade deterrents

Unsurprisingly, this not only presents a significant barrier to external investment, but also to the proliferation of intra-African trade; something that has been cited as one of the greatest economically-limiting factors in the region. Indeed, the United Nations Economic Council for Africa puts intra-regional trade volumes at only around 16% of the total trade flows on the continent – the lowest intra-regional trade proportions globally. With the output from many African countries becoming increasingly diversified, this figure should be substantially higher.

A primary reason for this is cost. While much can be attributed to non-tariff barriers, and insufficient payments infrastructure, the inability to access liquidity when required – particularly on perishable goods – is a major deterrent for traders wishing to engage with other African countries. Indeed, in many transactions, traders are forced to use an intermediary or “clearing” currency (usually the US dollar) to circumvent currency inconvertibility – automatically carrying an increase in cost and additional currency risk exposure. Informal cross-border trade (ICBT) has proliferated as a result – a phenomenon which ultimately supresses Africa’s economic potential. It is estimated that between 30-40% of intra-regional trade in Africa is made up of ICBT. And this is unlikely to change until the costs associated with formal trade are reduced substantially to encourage these volumes to move into the formal economy.

Levels of ICBT in Africa are intrinsically linked with the engrained problem of the dollar deficit in many central banks in the region. The withdrawal of capacity by many international banks during the global economic crisis put substantial pressure on the G10 reserves of many Africa’s central banks. The deficit has ultimately pushed up the cost on trade of “non-essential” goods as, in many cases, precious dollar reserves are only deployed on trade of goods deemed “essential” to a country’s economy – other traders being instead obliged to use the higher-cost services of a commercial clearing bank instead.

Collaboration is key

An enduring argument to resolve these many issues is to have a single African currency – an idea that has been experimented with on a smaller scale in the form of the West African Monetary Zone (in which six African countries share the Central African CFA Franc) and more recently with proposals around the Eco (a shared currency that 15 West African Nations hope to launch in 2020). But sceptics of any proposition to roll out a single currency across Africa’s 54 sovereign states argue that a unilateral monetary policy would be unable to properly serve the very nuanced and individual economic needs of each of Africa’s countries, and could create new and unforeseen problems.

But other collaborative initiatives could be the answer, however. One such is Afreximbank’s Pan-African Payment and Settlement Platform (PAPSP), which is available on mobile or computer devices and is aimed at reducing cash dependency by facilitating the electronic clearing and settlement for trade transactions denominated in African currencies. It was launched earlier this year and is being piloted in six African countries, to be later rolled out to any country wishing to opt in. The African Continental Free Trade Agreement (AfCFTA) was also signed by 44 African nations at the beginning of 2018, and removes 90% of tariff barriers on cross-border trade. These initiatives are all part of the combined strategy to formalise the volumes of ICBT and to ease trade flows across the continent.

A reliable partner

But these initiatives are in their infancy and the liquidity problem is far from resolved. A reliable FX partner with an advanced digital offering is key to overcoming immediate challenges around illiquidity. Currency trading platforms – such as Crown Agents Bank’s EMpowerFX platform – are the ideal way to access a broad selection of exotic currency pairings. Technologies such as these ensure that central and commercial banks are well-supplied with G10 currencies at competitive prices – facilitating trade and economic stability. Integrated live news feeds also provide clients with immediate visibility around market conditions and rate-influencing events, which can help local treasurers better manage their risk exposures with respect to exchange rate volatility.

In Africa’s FX landscape is certainly changing as the effects of the de-risking trend gradually begin to dissipate and digitization takes hold. While the volume of US dollar transactions is still high, we can expect to see a steady increase in regional currency transactions as technology and pan-regional collaboration ease trade flows across Africa. As African countries enter a new period of development and the multitude of new initiatives progress, it is down to their correspondent banking partners to support them and provide the necessary tools to help them flourish.

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