The debate surrounding the decision between fixed and floating exchange rate systems has intensified, particularly in the context of African economies. This discussion gains importance when considering the challenges faced by local currencies against the U.S. dollar. The pressure most of these African currencies are facing due to higher US interest rates complicates efforts to curb inflation in a region heavily reliant on imports. A pertinent case study is the fall of the Nigerian Naira which has weakened against the US dollar, fueling inflation as import prices surge amid a growth slowdown. Policymakers face tough decisions in balancing inflation control with a fragile recovery.
According to the International Monetary Fund, the U.S. dollar accounts for 60% of the transactions globally. In nations like Zimbabwe and Ethiopia, accessing dollars poses considerable challenges due to scarcity. Efforts to enhance liquidity through foreign exchange platforms outside the more developed South African market encounter persistent obstacles. The dynamics of currency depreciation are intricately linked to the level of central bank intervention and their willingness to deploy foreign exchange reserves to stabilize local currencies against the dollar.
The sub-Saharan region has experienced an average depreciation of about 8% since January 2022, with variations among countries, an IMF report on Managing Exchange Rate Pressures in Sub-Saharan Africa reveals. Ghana’s cedi and Sierra Leone’s leone depreciated by over 45%. External factors primarily drove these depreciations, including lower global market risk appetite and US interest rate hikes diverting investors to safer US treasury bonds. Economic slowdown in major economies reduced demand for the region’s exports, impacting foreign exchange earnings. High oil and food prices, partly due to Russia’s war in Ukraine, further increased import costs in 2022.
Large budget deficits in about half of the region’s countries, exceeding 5% of GDP in 2022, intensified demand for foreign exchange, putting pressure on exchange rates. Weaker currencies led to rising local prices, as most imports are priced in US dollars. Central banks have tried to support their currencies by supplying foreign exchange, but low reserve buffers limit intervention. Some countries resort to measures like foreign exchange rationing or banning foreign currency transactions, which can distort markets and foster corruption.
One of the primary dangers of floating local currencies in Africa against the dollar is the heightened volatility experienced by these currencies. The Naira, for example, has witnessed sharp fluctuations, impacting businesses, trade, and overall economic stability. Investors are deterred by such uncertainty, leading to reduced foreign direct investment and capital flight.
Floating of local currencies has exposed African economies to inflationary pressures. This contributes to rising prices of imported goods and services, which places an additional burden on consumers and businesses, disrupting long-term economic planning and growth. The depreciation of local currencies against the dollar leads to an increase in external debt burdens for African nations. Countries that heavily rely on foreign-denominated debt find themselves facing higher repayment obligations, as the value of their local currencies diminishes. This situation, as seen in various African economies, can result in a debt trap that hampers economic development.
When currencies are floated against the dollar, it exacerbates trade imbalances, as the relative strength of the U.S. dollar makes imports more expensive for African nations. The currency’s depreciation contributes to trade deficits, impacting the overall balance of payments. Persistent trade imbalances can strain foreign exchange reserves and undermine economic stability.
The volatility associated with floating local currencies creates opportunities for speculative activities in the foreign exchange markets. Speculators can exploit fluctuations in exchange rates for short-term gains, further destabilizing the currency. This illustrates the challenges of managing speculative pressures and maintaining currency stability.
Strongest Currencies in Africa
- Tunisia – 3.13 Tunisian Dinar/$
- Libya – 4.83 Libyan Dinar/$
- Morocco – 10.0 Moroccan Dirhams/$
- Ghana – 12.39 Cedi/$
- Seychelles – 13.48 Seychellois Rupees/$
- Botswana – 13.70 Botswana Pula/$
- Eritrea – 15.0 Eritrean Nakfa/$
- Lesotho – 18.98 Lesotho Lotis/$
- Namibia – 18.97 Namibian Dollar/$
- South Africa, Eswatini – 19.02 South African Rand/$
Weakest Currencies in Africa
- São Tomé and Príncipe – 22,281.8 Dobra/$
- Sierra Leone – 19,678.65 Leone/$
- Guinea – 8,583.4 Guinean Franc/$
- Madagascar – 4,528.28 Malagasy Ariary/$
- Uganda – 3,849.94 Ugandan Shilling/$
- Burundi – 2,849.21 Burundian Franc/$
- Democratic Republic of Congo – 2,752.27 Congolese Franc/$
- Tanzania – 2,540.00 Tanzanian Shilling/$
- Malawi – 1,680.27 Malawian Kwacha/$
- Nigeria – 1,500.50 Naira/$
With persistent external shocks expected, countries with flexible exchange rates must let them adjust and tighten monetary policy. Those with pegged exchange rates need to align with the pegged currency. Fiscal consolidation and structural reforms can help address external imbalances and limit debt increase from currency depreciation.
While floating local currencies against the dollar may offer flexibility, the risks, and challenges associated with this approach, as evidenced by the fall of the Naira and other African currencies, cannot be overlooked. African nations must carefully weigh the benefits against the potential dangers, considering alternative exchange rate regimes that foster economic stability and sustainable growth. Striking a balance between flexibility and stability is imperative to navigate the complexities of the global economic landscape and secure a prosperous future for the continent.
