With the U.S. Federal Reserve’s tapering decision still roiling confidence in emerging markets, the currencies of Africa’s three largest economies – South Africa, Nigeria, and Kenya – have all reacted differently.
The Fed announced in May that it would scale back its quantitative easing program of injecting liquidity into financial markets through the widespread purchase of U.S. government bonds.
It’s too early to tell whether these trends will continue given the wide degree of uncertainty that exists in foreign exchange markets, but an understanding of the structural differences between them may provide an insight into where these currencies could be headed.
The Nigerian naira slid slightly against the U.S. dollar last week, falling to 163.34 from 163.02 last Monday. This slip in valuation continues a pronounced downward trend in valuation against the dollar that began in May. Nigeria, a country rich in oil but otherwise suffering a host of political and economic problems, has accumulated significant foreign debt in recent years – some $50.8 billion, or $14 billion more than the country owed in 2003 when a debt crisis caused its currency to plummet in value from around 130 naira to the dollar to 150 naira to the dollar.
The currency and the Nigerian economy recovered, spurred in part by cost-cutting measures taken up by the federal government, a rebound in the price of oil – which by 2008 reached a high of $147 to the barrel – and investor bullishness in developing economies, including Nigeria’s. The long run up in oil – spurred by Chinese demand and the housing bubble in the U.S. – led to the naira reaching a 10-year high against the dollar of 113.36 to the dollar in early March of 2008.
Following this peak the global financial crisis crushed the price of oil, taking the high-flying naira with it – reducing the Nigerian currency to a 10-year low of 164.85 to the dollar in late December of 2011. The naira since recovered, trading below 160 to the dollar for most of 2012 and 2013, but the slide in valuation since May to consistent trading above the 160 mark indicates that, despite efforts by the Nigerian central bank to prop up the naira’s value, global investors have reduced confidence in the strength of the country’s economy.
This naturally reflects the overwhelming dependence of Nigeria on oil for economic growth. Oil accounts for some 80 percent of gross domestic product. With little in the way of an export-centered manufacturing or service sector present to take advantage of a sinking currency, market expectations of lower oil prices going forward combined with rising concern over Nigeria’s increased debt will naturally lead to a falling currency – which is exactly what we are seeing.
In contrast, South Africa’s currency ended the past week on a brighter note, climbing to a high of 10.01 rand to the dollar from a low of 10.34 rand to the dollar earlier in the week. This improvement occurred despite continuing labor unrest in the crucial mining sector and very high levels (about 15 percent) of unemployment. Increased optimism resulted from news that the South African economy grew at an annualized rate of 3 percent, which beat market expectations.
The source of this increase in growth is apparently an uptick in manufacturing and services, all of which are finally taking advantage of a long slide in the value of the rand that began in March of 2012. Then, the rand traded at 7.65 to the dollar, but has since fallen to its present value. This has made exports sourced from Africa’s most highly-developed manufacturing sector cheaper vis-à-vis competitors, spurring growth in all areas connected to it. This in turn indicates the basic strength of the South Africa’s more-developed economy compared to Nigeria’s.
Whereas Nigeria lacks non-oil-export industries large enough to offset oil price declines, South Africa does, suggesting that that South African currency may eventually settle its slide as the pace of manufacturing picks up even further. If labor unrest can be contained – admittedly a big “if” – then the rand could even be due for an uptick in valuation as growth in mining and manufacturing begins to push up employment.
Kenya’s currency ended the week relatively flat – beginning at 87.53 shillings to the dollar and ending slightly up in value at 87.40 to the dollar. This repeats the shilling’s performance over the past month where it traded in a range from 87.40 to the dollar to just over 87.60 to the dollar. In turn, this reflects an attempt by the government to keep the shilling in a trading range between 80-to-90 shillings to the dollar over the past two years, at which it has been relatively successful.
Kenya, lacking both the sophisticated manufacturing of South Africa and an oil production industry like Nigeria’s, more-or-less reflects the structural patterns of the rest of underdeveloped Africa. Kenya is highly dependent on non-oil mineral and agricultural exports to the West, the Middle East, and East Asia. Lately, it has been a focus for foreign investment, particularly China, which has invested heavily in infrastructure, mining, and other extractive industries. A nascent energy sector is developing as East Africa undergoes a petroleum -and natural-gas-exploration boom.
This suggests that inflowing capital related to long-term Chinese investment and oil-and-gas exploration and development may well offset any losses imposed by tapering on the Kenyan currency. This may explain the rather tepid response the shilling has had so far to the Fed’s announcement.
The lesson here is that one should not take a simple, one-answer-fits-all approach to understanding and interpreting currency movements among Africa’s emerging economies. Structural differences are important factors that differentiate responses to news like the Fed’s tapering announcement. Investors should react accordingly.
If a country is fundamentally sound with good prospects for increasing exports or drawing foreign investment into its real economy – such as South Africa and Kenya – tapering is not necessarily such bad news. On the other hand, if a country is highly indebted and has a falling terms-of-trade with the rest of the world due to a dropoff in the price of its main export commodity – then an investor has right to be worried.
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