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Strong dollar makes African countries miserable

Victor by Victor
07/12/2022
in News
What is a token?
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The dollar has been rising rapidly as the Federal Reserve is determined to keep raising policy rates for longer to regain control of persistently high inflation. This has wide-ranging implications, as the dollar is widely used around the world as an international medium of exchange and a global reserve currency.

Africa is already battered by rising inflation sparked by the Ukraine war, while the dollar is strengthening. Inflationary pressures are building across the continent as the dollar strengthens. This makes it harder for central banks to curb high inflation. More pain will be felt as a stronger dollar has knock-on effects in Africa, squeezing trade volumes, tightening trade finance terms, and ballooning sovereign debt and soaring debt-servicing costs.

Another concern is the risk of a dollar doomsday cycle. As the dollar strengthens, it drags on global economic activity, forcing other currencies to depreciate and strengthening the dollar further. This outcome further dampens economic activity and exacerbates currency weakness, triggering a self-reinforcing vicious circle.

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Unfortunately, African countries have little recourse against a strong dollar. Most countries are facing challenges.

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For example, the Ghanaian Sedi, the Egyptian Pound and the Zimbabwean Dollar have fallen sharply and are now among the top 10 worst performing currencies in 2022. Other currencies such as the Kenyan shilling and the South African rand also weakened under pressure from a strong dollar.

While a strong dollar does make African exports more competitive, the gains from a weak currency may end up being modest. Because exports are usually denominated in dollars. So while a devalued currency makes goods cheaper in domestic currency terms, it doesn’t always mean that foreign buyers paying in U.S. dollars get cheaper goods.

Dollar denomination is also a prominent feature of trade finance in developing countries. Companies that trade in commodities rely heavily on bank financing to finance their operations because of the varying timing of incurring costs and repatriating funds.

A stronger dollar has tightened trade finance terms, limiting companies’ access to financing. This offsets the increase in export competitiveness, further depressing foreign trade.

The African Development Bank has conducted in-depth research on trade finance across Africa. These studies show that banks see a lack of sufficient dollar and euro liquidity as an important constraint on trade finance.

Rapid U.S. interest rate hikes are the main driver behind the acceleration in dollar strength. This has strained the financial situation of heavily indebted African governments.

Higher interest rates increase the debt service burden and heighten concerns about debt sustainability, especially for more than two dozen African countries that the IMF and World Bank consider to be at high risk of debt distress or already Trapped in debt.

How should African countries respond to a strong dollar?

The options are few and far between and challenging. In the short term, African countries have two main options.

The first is to continue to raise interest rates to resist the currency depreciation pressure brought about by the strong dollar. However, if policy rates continue to rise, it will squeeze economic output and could tip some African economies into recession.

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The second is to contain currency depreciation pressures by intervening in currency markets. This requires the use of foreign exchange reserves to support the domestic currency. This approach is not widely available. Many African countries have implemented massive public spending programs and paid more for their goods imports during the COVID-19 pandemic, and reserves are running low.

Given that a weaker currency increases the purchasing power of overseas tourists, another option is to boost tourism to help support the local currency in the short to medium term.

Tags: IMFinflationinterest rates
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The Reserve Bank of India raised interest rates by 35 basis points, raising the rate to 6.25% from 5.90%, in line with market expectations.

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The Bank of Canada announced its interest rate decision tonight, or further narrowed the rate hike to 25 basis points

Victor

Victor

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