U.S dollar effect on Africa in 2024

The region’s reliance on imports makes it more difficult to combat inflation when currencies are weaker

Policymakers at the Federal Reserve stated that they intend to cut interest rates by as much as 75 basis points in 2024, an announcement that has fueled optimism in Africa’s emerging and frontier markets.

Since March 2022, the Federal Open Market Committee has voted to raise interest rates 11 times to curb U.S. inflation, which peaked at just over 7% in mid-2022. The federal funds rate, which was virtually zero during the coronavirus pandemic, is now at a 20-year high of 5.25% to 5.5%.

Rising interest rates in the US contributed to the strength of the US dollar, and foreign exchange traders tended to increase their exposure to the US dollar in hopes of higher returns.

African countries are having increasing difficulty accessing the haven currency to buy imports and make payments to foreign investors as they become unintended victims of developed countries’ fight against post-pandemic inflation.

Ironically, this situation is accelerating inflation for African countries as their currencies depreciate, and there is no quick fix. Countering this trend requires increasing exports and stimulating domestic production to replace imports.

African currencies have recently suffered severe depreciation, especially against the respected US dollar. This currency devaluation has raised concerns about the economic stability of several African countries affecting trade balances, inflation rates, and people’s purchasing power.

The devaluation of a country’s currency is mainly due to its heavy dependence on raw material exports. This is especially true in countries such as Nigeria and Angola, where raw materials such as oil and minerals account for most of the export activity. The Nigerian naira was the worst-performing African currency in 2023 amid the devaluation of local currencies.

Several African nations, particularly economically significant ones like Nigeria, are predicted to experience currency devaluation in the upcoming year, according to a report from The Economist Intelligence Unit. According to the analysis, the effects of devaluation in 2024 will be milder than they were this year.

“While the adjustment will not be as severe as in 2023, we expect a significant currency devaluation against the US dollar in most parts of Africa in 2024.

We expect a more severe adjustment than in 2023,” the EIU report stated. Lack of infrastructure also complicates intra-African trade. Achieving a Continental Free Trade Agreement will require prioritizing trade volumes.

The currencies of South Africa, Namibia, and Botswana also suffered significant devaluation due to the US dollar; however, in 2024, currency stabilization seems to be the most probable result.

The research clarified that if the Central Bank of Nigeria continues to advocate for unfavorable monetary policies, pressure on Nigeria’s currency will persist. It further stated that the CBN lacks the “firepower” necessary to clear the estimated $7 billion in currency backlog and boost market confidence.

Local importers and non-resident investors typically require hard currency (primarily US dollars) to pay suppliers and repatriate investment proceeds.

In countries with currency controls, dollars are supplied by the central bank, which receives dollars through exports, overseas remittances, foreign loans, and tourism.

Dollars have been flowing out of some of Africa’s major investment destination economies such as Egypt, Nigeria, and Kenya for months.

This puts tremendous pressure on the local currency. Most sub-Saharan African currencies have depreciated against other world trading currencies such as the British pound and the US dollar, resulting in the loss of value and purchasing power of these local currencies on the African continent.

Rising costs of living, as imported goods become more expensive in local currencies, are increasing operating costs for businesses, slowing economic growth, and discouraging new investment.

Interventions in the foreign exchange market to ease pressures helped, but at the same time significantly depleted foreign exchange reserves and led to increased hard currency rationing and greater dependence on foreign exchange for import operations.

Other management measures are being promoted, such as lowering imports. The big problem is that there is a huge gap between the demand and supply of foreign exchange in these countries. As soon as there is a shortage of foreign currency, people are forced to resort to alternatives such as the black market.

Black market interest rates are always worse than official rates, so only wealthy companies and individuals can afford to pay for imports, raw materials, tuition, medical expenses, tourism, etc. Another factor is the high dependence on imports, one common to many African countries.

Many African countries import far more industrial products than they export. As a result, foreign currencies such as the US dollar and Chinese renminbi are required to pay international suppliers of these goods, increasing foreign currency demand and reducing dependence on local currencies. Dollarization of the economy is not uncommon in parts of the continent.

Leading African oil exporter Nigeria profited from increased global crude prices, but delays in currency processing have been caused by a decline in foreign investment inflows to the lowest level in six years.

Most African nations are classified as low- and lower-middle-income by the World

Bank, meaning that their economies depend on imports of capital goods like farm machinery and industrial machinery. Local currencies are constantly under pressure because payments are usually made in dollars, euros, and yen. Foreign investors look for better yields on debt denominated in their home currency and stock market returns that significantly outpace inflation rates to offset the foreign exchange risk.

Even if a weaker dollar helps many African currencies gain ground in 2024, these more fundamental factors suggest that many African currencies are not necessarily on a stable long-term footing.

The International Monetary Fund also recommended key measures for the Sub African continent that might lessen the effects, but each will call for sacrifices from the citizens of the affected nations. Policymakers can tighten monetary conditions, often accomplished by raising interest rates, when inflation is caused by declining currencies. This is beneficial for attracting foreign investment but problematic for domestic borrowers. Budget deficits can be reduced by governments, but doing so would mean raising taxes or cutting expenditures, neither of which are popular with the electorate.

This content is for educational purposes only. It does not constitute trading advice. Past performance does not indicate future results. Do not invest more than you can afford to lose. The author of this article may hold assets mentioned in the piece.

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