In my discussions with clients and investors, the topic of currency markets always comes up. While we often talk about the domestic policy and external balances of economies and how they impact currency values, we rarely discuss the outsized impact of the US Dollar on emerging market countries.

The movements of the US Dollar can have a magnified impact on emerging market countries due to the significant proportion of global fuel and food priced in US Dollars. This was particularly evident in 2022 when the US Dollar appreciated significantly against most global currencies, causing a massive headache for central banks everywhere.

For most countries, the unpalatable choices were to either hike interest rates to prop up their currency or let their currency depreciate, making imported food and fuel even more expensive. This resulted in some countries instituting fuel or food subsidies, which increased budget deficits and drove debt levels higher.

Moreover, most African countries still rely on US dollar-denominated debt to finance their economies. As local currencies devalue, dollar debt repayments become more expensive, pushing more countries towards a potential debt crisis.

The macroeconomic shocks, combined with governmental policy and central bank missteps, have pushed some currencies to historic lows. Countries that fared better typically have one of two things in common: they are either net fuel exporters or they applied quasi or actual capital controls to limit the depreciation of their currency.

While restricting capital outflows might provide the illusion of control to a hard-pressed Central Bank, it has two majorly negative implications for the real economy. Firstly, importers find it very difficult to access US Dollars, leading to either a parallel FX market forming or access to essential imported goods becoming problematical. Secondly, investors are deterred from investing in that country due to fear of being unable to repatriate capital.

The stronger dollar may be viewed as an opportunity for Africa, but the rush to emerging markets will not materialise if foreign investors remain nervous about continued local currency depreciation and its impact on local currency returns once converted back into dollars.

Luckily, the US Dollar has since dropped in value by over 10 per cent against most major currencies, giving some much-needed relief to the hardest-hit countries. However, African countries need to work independently or collectively to mitigate the risk of future gyrations of the US Dollar.

Kenya’s ambitious programme to introduce a repo market in 2023, backed by a local Central Securities Depository, should improve liquidity in the underlying bonds, cheapening the level at which it can issue local currency debt. This initiative should be applauded, and other African countries should follow suit.

In summary, Africa is over-exposed to the US Dollar, and its constituent countries need to take action to reduce this risk before the next bout of dollar strength arrives.

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