Currency volatility in emerging markets has become a key concern for policymakers, investors, and multinational corporations alike. Characterised by rapid and often unpredictable fluctuations in exchange rates, currency volatility has weighty implications for trade, investment, and economic stability.
Emerging markets, with their evolving economic structures and often fragile political environments, are particularly susceptible to these fluctuations. Managing currency risk in such markets requires a deep understanding of underlying economic fundamentals, proactive risk management strategies, and adaptive policy measures.
Data from the Institute of International Finance (IIF) shows that globally, emerging markets experienced net capital outflows of $243 billion in 2022, largely driven by global economic uncertainties and tighter monetary policies in developed economies.
In Africa, this volatility is particularly pronounced due to several factors, including political instability, reliance on commodity exports, economic mismanagement, and global financial market trends. The continent is home to 54 nations, each with its economic policies, political dynamics, and currency regimes. As such, currency performance varies widely, from the more stable West African CFA franc to the highly volatile Zimbabwean dollar.
According to the International Monetary Fund (IMF), the median annual depreciation of sub-Saharan African currencies against the US dollar was around 7% between 2010 and 2020. However, some currencies experienced much steeper declines. Angola’s kwanza, for example, lost nearly 50% of its value in 2020 alone, driven by declining oil revenues and mounting debt pressures.
Causes of Currency Volatility in Africa
Several underlying causes contribute to the currency volatility observed across African nations:
Commodity Dependence: Many African economies are heavily reliant on commodity exports such as oil, gold, and cocoa. As a result, fluctuations in global commodity prices can significantly impact their exchange rates. Oil-exporting countries like Nigeria and Angola have seen their currencies decline in value during periods of low oil prices, exacerbating inflationary pressures and reducing the purchasing power of consumers.
African countries are not solely susceptible to these economic fundamentals. Brazil and Russia, both major commodity exporters, have seen their currencies fluctuate in response to changes in global commodity prices.
- Political Instability and Economic Governance: Political uncertainty and economic mismanagement can undermine investor confidence and destabilise currency markets. Zimbabwe’s long history of hyperinflation, currency collapses, and economic mismanagement has led to recurrent crises, including the adoption and abandonment of the US dollar as its official currency.
- Monetary Policy and Inflation: Weak monetary policies and high inflation rates can also contribute to currency depreciation. In many African countries, central banks struggle to maintain price stability due to external shocks and internal pressures. Ethiopia, for example, has faced double-digit inflation in recent years, leading to consistent depreciation of the birr. Similar to how back in 2021, Turkey’s lira experienced severe depreciation following abrupt changes in central bank leadership and unorthodox monetary policies.
- External Debt Levels: Rising levels of external debt and fiscal imbalances have placed additional pressure on African currencies. Countries like Zambia, which defaulted on its sovereign debt in 2020, have seen their currencies weaken due to concerns over debt sustainability and access to international capital markets.
Managing Currency Risk in African Markets
Given the complex dynamics at play, managing currency risk in Africa requires a multi-faceted approach. Investors and businesses need to employ both financial and operational strategies to mitigate the impact of exchange rate fluctuations.
- Hedging Strategies: For corporations and investors, hedging strategies can mitigate the impact of currency volatility. This can involve the use of financial instruments like currency forwards, options, and swaps. Many multinational corporations operating in volatile markets such as Brazil or Turkey employ hedging strategies to protect their earnings from adverse currency movements.
- Diversification of Trade and Investment Flows: Businesses operating in Africa can mitigate currency risk by diversifying their investments across multiple countries and industries. This approach helps to spread the risk of currency volatility, as downturns in one market may be offset by gains in another. For example, companies with exposure to both oil-exporting and oil-importing countries can balance the impact of commodity price swings on their operations.
- Local Currency Financing: Securing financing in local currency can help businesses avoid exchange rate risk altogether. Development finance institutions (DFIs) and regional banks, such as the African Development Bank (AfDB), have been increasing their efforts to provide local currency loans to companies operating in Africa. These initiatives reduce the dependence on hard currency loans, which can become prohibitively expensive during periods of currency depreciation.
- Political Risk Insurance: Given the political uncertainties in many African countries, businesses can also manage risks through political risk insurance. Organisations such as the Multilateral Investment Guarantee Agency (MIGA), a member of the World Bank Group, offer insurance against losses resulting from currency inconvertibility, expropriation, and political violence. Such coverage can provide reassurance to investors and help them navigate the volatile political landscapes of African markets.
- Capital Controls and Regulation: In some instances, emerging markets have implemented capital controls to limit excessive currency volatility. While controversial, such measures have been used effectively in countries like Malaysia during the Asian financial crisis. However, the long-term use of capital controls can deter foreign investment, making them a tool of last resort.
The Role of Regional Integration
One of the key initiatives aimed at reducing currency volatility in Africa is the African Continental Free Trade Area (AfCFTA), which came into effect in January 2021. The AfCFTA aims to create a single market for goods and services across the continent, reducing trade barriers and promoting economic integration. By fostering greater intra-African trade and investment, the AfCFTA has the potential to reduce the continent’s dependence on external markets and currencies, thereby mitigating exchange rate risks.
Moreover, there are ongoing discussions around the creation of regional currency blocs, similar to the West African Economic and Monetary Union (WAEMU), where eight countries share the CFA franc. Such initiatives could help to stabilise currencies and enhance economic coordination among African nations.
