AfkInsider Forex Africa Report: If the Fed Tapers, Will Africa Tumble?

AfkInsider Forex Africa Report: If the Fed Tapers, Will Africa Tumble?

The big news this past week was the announcement by the U.S. Federal Reserve that the American central bank would begin “tapering off” its program of quantitative easing sometime later this year, possibly as soon as September. While the Fed’s move to tighten the U.S. money supply after many years of historically loose policy in the wake of the 2008 market collapse and global recession has long been expected, the quickness of the move has nonetheless set emerging markets reeling.

With many hundreds-of-billions of U.S. dollars having been funneled into emerging markets to take advantage of higher interest rates there since the collapse, the Fed announcement has served to prick what some have termed a “hot money” investment bubble that has developed in many emerging economies. For investors with long memories, this has raised the specter of another emerging-market financial crisis similar to the one that rocked Asia in the 1990s.

While the situation is not yet nearly as dire as that earlier crisis, several emerging-market currencies have taken a shellacking. India and Indonesia, for instance, have both seen their currency nosedive in the aftermath of the Fed’s announcement with the Indian rupee closing above the historical low of 65 to the dollar while the Indonesian rupiah fell to a four-year low against the American currency. In Africa, however, the situation is likely to be more mixed as a stronger U.S. dollar will mean different things for different countries.

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In South Africa, the Fed’s tapering news will put added downward pressure on the rand – which has been declining in value against the greenback for months due to a sluggish economy and continuing labor strife in the mining sector. For the major gold producer and exporter, the U.S. announcement will doubly hurt as demand for gold will tumble further as the dollar strengthens. All this is bad news for a struggling South Africa, which will now have to become a lot more attractive if it is to attract the capital inflows it needs to grow. Expect the rand to sink further.

In the rest of emerging Africa, the news is more mixed. A stronger U.S dollar and a stronger U.S. economy may mean a rebound in commodity prices as U.S. consumers begin to open their wallets after a long, downturn-driven hiatus. Not only would this mean a direct increase in U.S.-Africa trade, but an indirect increase in Chinese demand for African commodities as well since U.S. consumer spending is directly tied to the health of the export-dependent Chinese manufacturing sector. As both U.S. consumer spending and Chinese factory activity look to be on the uptake, this should be good news for Africa’s commodity producers and, therefore, African currencies.

So far, this seems to be how news of the Fed’s tapering announcement is playing out in many of the smaller African currency markets. The Tanzanian shilling, for example, dipped slightly against the U.S. dollar but otherwise remained fairly strong vis-à-vis other currencies – what one would expect from a commodity producer well placed to service increased global demand from both the U.S. and China. In Zambia, a similar process may be at work as the kwacha ended higher for the week despite investor angst roiling markets from Jakarta to Rio.

So, as the fallout from the Fed’s tapering announcement plays out in the days ahead, expect three broad trends. First, volatility will reign as the macroeconomic effects of tapering manifest themselves fully. This may lead to speculative attacks against currencies with current-account deficits, weak economic prospects, or little in the way of hard currency reserves.

Second, while all Africa will no doubt experience downward pressures on their currencies as a result of tapering, those countries that have played host to hot investment money will be most affected. It is in those countries, such as Nigeria, South Africa, and possibly Kenya where investors seeking refuge from a weak U.S. dollar invested most. Hot money, therefore, can be expected to flow out of these countries – so expect big currency declines there.

Third, in those smaller African economies which have seen less exposure to global investment flows and that possess a more traditional, export-led, commodity-based economy, investors should expect to see less pressure on their currency as stronger demand from traditional export markets in the West and China compensate for any losses that may accrue due to investor flight to higher returns in the U.S.