Currency war: the stakes for Africa
Africa's economic outlook could suffer if foreign investment pushes up the value of its currencies and cripples exports
Sunday 21 November 2010 10.00 GMT
As a result of chronically deficient demand in the aftermath of the 2008-09 financial and economic crises, global imbalances are on the rise again, as is the risk of protectionism. The US thinks China is undervaluing its currency to support its industry. The situation could lead to an "international currency war". What does this herald for African countries?
If history is any guide, we might look into previous currency conflicts to gauge the future. In the 1930s, currency wars led to competitive devaluations, protectionism, high inflation, economic collapse, the rise of Hitler in Germany, and eventually the second world war.
Africans were drafted in their thousands to fight alongside the allied forces against the axis armies. Many of them died. Africa's consolation prize came with the political awakening, the fight for freedom, and the independence that followed.
Postwar international euphoria did not last long before another currency conflict struck. In 1971, President Richard Nixon levied a 10% import surcharge and ended dollar convertibility into gold. This is how the debt-economy was born, further compounded and universalised by the Big Bang, the fall of the Berlin Wall, the repealing of the Glass-Steagall Act, China's embrace of the "one state, two systems" model – totalitarian politics and economic liberalism – and globalisation.
Cheap money flooded the world, leaving out African countries, which – except for white-ruled South Africa and Northern Rhodesia (Zimbabwe) – were locked out of capital market borrowings. Again, their consolation came when, devoid of toxic assets, they escaped almost unscathed the current twin woes of financial turmoil and economic downturn.
Quantitative easing (QE) adopted by the US Federal Reserve, the Bank of England, the European Central Bank and the Bank of Japan – printing hundreds of billions of dollars of electronic money – is the current weapon of choice in an escalating global currency war. Since the official interest rates set up by these central banks are close to zero, QE is flooding emerging market economies as investors search for higher yields. As a result, the exchange rates of their currencies are rising.
This invokes the 1985 Plaza agreement, whereby the US pressurised Japan into an appreciation of the yen. Japan never recovered from the huge monetary expansion that followed. China is unlikely to follow in Japan's footsteps. With its huge population, immense foreign exchange reserves and capital control, Beijing still has considerable scope to thwart speculative capital inflows and expand domestic demand to ward off western currency bullying.
Africa is being caught in the crossfire of this currency clash. In South Africa, the continent's biggest economy, capital inflows induced a rally in the rand, which last month rose to its highest level against the dollar in almost three years, undermining key export-led industries.
The CFA franc, which is freely convertible into hard currency at a grossly overvalued parity pegged to the euro, is still more vulnerable. The franc zone, which gives France control of 65% of the African member-countries' foreign-exchange reserves deducted directly from their oil, gold, cocoa, coffee and other commodities' exports earnings, will be a first choice for hot money inflows.
A foreign exchange cover of 110%, combined with soaring interest rates, low inflation and free capital movement, fuels capital flight to the benefit of France and French private companies. Moreover, the franc zone is particularly attractive to speculative capital inflows. Speculators transfer huge amounts of money to high-interest local accounts, collect their tax-free gains every three months, and take the no-risk plunge over and over again.
The brewing currency war is all the more unwelcome in Africa when one considers that the continent is enjoying a particularly good economic outlook. According to McKinsey & Company, Africa was the third-largest contributor to world economic growth in 2009, after China and India. It also credits the continent with delivering the highest rate of return on foreign investment.
Several factors have contributed to this upturn. Rapid urbanisation – 40% of Africans live in cities – has created a dynamic informal sector. This cash-based economy is a major contributor to the continent's productive capacity. It employs over 90% of the workforce, is home to three-quarters of retailers, and plays a leading role in increasing regional trade. By 2015, Africa will be the only continent where the working age percentage of the population will still be growing. The number of households with earnings over $5,000 – a threshold for consumption spending – will rise from 85m to 128m in the next decade.
Increased demand from emerging countries such as Brazil, India and China has pushed up commodity prices and increased export revenues. The scramble for large-scale purchases and leases of hundreds of thousands of hectares of farmland in the region has made the headlines across the world. There is no doubt that the opacity and the dubious conditions surrounding some of these deals are cause for concern. However, the fact remains that investment to harness Africa's huge agricultural potential is one answer to rising global food prices, "food riots", and climate change-induced food security concerns.
Economic reforms implemented throughout the 1970s and 1980s have improved the macroeconomic environment. Annual foreign direct investment flow in Africa rose from $9bn in 2000 to $62bn in 2008.
These are the bright development prospects that the currency sabre-rattling could jeopardise. However, Africa might find consolation in the fact that when the world's major economies are in trouble, wary investors find solace in "refuge values" like gold, silver, oil, base metals and other commodities in which Africa abounds.