Since lower oil prices typically result in depreciation of the oil exporters’ currencies, the dramatic plunge of oil prices has severe implications for sub-Saharan Africa.
After the global financial crisis, many emerging economies have coped with diminished global growth prospects by deploying direct government intervention and capital controls for competitive devaluation. In turn, advanced economies have achieved the same indirectly through low policy rates and quantitative easing (QE).
As the U.S. is recovering but Europe is amid its first ‘lost decade’ and Japan has begun its third one, the Fed is likely to hike its rates in the fall or by early 2016. Interest rates will remain zero-bound in Europe and Japan, and monetary easing will continue in emerging Asia. After rate cuts, further easing, correction in equity markets and subsequent rate adjustment in China, US dollar has climbed to 6.36 renminbi.
In Africa, the early effects of a stronger dollar have been far more extensive, however.
In 2014, US dollar rose from about 160 naira to 180. It peaked at around 204 in February and has been around 199 ever since. In the black market, however, the naira has traded around 220, and occasionally as low as 240 to the dollar. These figures reflect the ongoing struggle between those who support a strong naira and those who would prefer a devalued naira.
As oil prices plunged to below $50 per barrel, Nigeria began to limit dealing and prevent dollar outflows. In contrast to some other oil exporters, including Russia and Colombia, President Buhari and central bank Governor Godwin Emefiele oppose a devalued naira.
Investors’ unease has been reflected by JPMorgan Chase’s decision to cut Nigeria from its local-currency emerging-market bond indexes.
During the Jonathan rule, foreign investors were uneasy with the polarization between the president and the central bank. In the Buhari era, the cause of their unease is precisely the reverse: the perceived close association between the central bank and the president. Buhari opposes depreciation, which he believes would stoke inflation that already exceeds 9 percent. That view is supported by Governor Godwin Emefiele’s efforts to restrict foreign-exchange trading to stabilize the naira.
This policy stance may prove untenable over time, however. It is alienating foreign investors, local businesses and the critics of the Monetary Policy Committee who believe that an overvalued naira deters capital inflows and hinders economic growth. A year ago, McKinsey expected Nigeria to grow at 7.1 percent a year through 2030. In the ongoing year, economic growth dropped to 2.4 percent in the second quarter.
Excessive reliance on oil revenues and inadequate structural diversification has already subdued Nigeria’s BRIC-style growth dreams.
Struggling African currencies
In Africa, plunging oil prices have hit hard major oil exporters. Oil exports account for almost half of the GDP for oil-exporting African countries, such as Gabon, Angola and the Republic of Congo and far more in Equatorial Guinea. In most of these economies, oil also accounts for most of government revenues.
As Africa’s second-largest oil producer, Angola produces some 1.8 million oil barrels per day but remains critically dependent on oil for revenues. In 2014, US dollar increased from about 98 to 103 Angolan kwanza. As a result, net oil export revenue plunged by over 12 percent. But that was only the beginning. During the ongoing year, US dollar has soared to 135 kwanza, and Angola has halved its 2015 oil price assumption to $40 per barrel. As social conditions have deteriorated, Luanda has courted international lenders for more than $1 billion in loans.
As local currencies depreciate, central banks must often struggle to fight speculation, which may discourage foreign investors’ new investment. Concurrently, political risks typically become elevated, especially when fiscal buffers are inadequate.
South Sudan, which had bet on a $100-a-barrel oil price, is an extreme case. Due to a mix of plunging prices and highly unfavorable pipeline contracts, Juba got the lowest oil price worldwide ($20-$25). In Nigeria, Boko Haram has created a security risk that has compounded foreign investors’ unease about central bank’s measures.
These pressures put government into a damned-if-you-do-and-damned-if-you-don’t situation. Either they must adjust expenditures, which will harm the more vulnerable social classes, or they must devalue the currency, which could result in higher inflation. In both cases, governments risk alienating their constituencies, destabilizing the economy and triggering social unrest.
Of course, plunging oil prices are not a tragedy to all African economies. In effect, oil importers – including South Africa, Tanzania, Kenya and Ethiopia – will be the perceived winners. Nevertheless, even these countries will not be spared from currency friction.
In 2014, US dollar climbed from 10.50 to 11.60 South African rand. This year it has continued to strengthen and rand has weakened to 13.92 per dollar. Indeed, the rand has declined over 20 percent against the dollar.
In turn, US dollar increased from 1,560 to almost 1,700 Tanzanian shilling in 2014. Recently, the shilling has weakened closer to its perceived “equilibrium,” according to the IMF, while US dollar has soared to more than 2,152 shilling. In addition to depreciating by almost 25 percent against the dollar, Tanzanian shilling has been weakened by high liquidity, seasonally low export income and high repatriation of corporate dividends.
Currency wars déjà vu
Recent currency friction will not lessen in the coming months. Rather, the combined Fed-oil-currency effect will expand toward 2015/16.
Before the crisis year of 2008, U.S. policy rate still exceeded 4 percent. Assuming the first hike will ensue by late fall 2015/early spring 2016 and subsequent increases will follow incrementally, that level will not be restored until 2018-2020. By then, the US will have benefited from low rates for a decade and from $4.5 trillion of QE for half a decade. Meanwhile, US sovereign debt has soared to $18.4 trillion, which exceeds the size of the economy. A new budget battle and risk of a government shutdown has been deferred until the year-end. And yet, US dollar is seen as strong.
In the medium-term, the demise of the dollar-denominated commodities world is already looming, in part because of the impending internationalization of the renminbi. In early August, the IMF was asked to delay its RMB inclusion until September 2016. But even if China misses the cut in fall 2015, there is a significant likelihood of an interim review that will grant Chinese currency SDR status before 2020. By some estimates, some 10 percent of the global reserves — more than US$1.1 trillion — could flow into RMB assets which would herald a new era in the global capital markets.
In the absence of structural reforms, stagnation in America, Europe and Japan is being contained by unsustainable leverage, historically low policy rates, and excessive quantitative easing, which, taken together, translate to a decade-long currency war. In emerging economies, these headwinds translate to substantial “collateral damage.”
The transition from the “exorbitant privilege” of the US dollar to a more balanced and diversified multipolar world economy has begun.