Where Are African Currencies Headed After The Coronavirus Pandemic?

In modern times, the different waves of economic crisis have blown similar torrents. Initially, the crisis begins with huge uncertainties that always convey indeterminate levels of risk, such that the probable measures of the impact of the crisis are unknown and incalculable. This was the case when the invisible coronavirus emerged; it was also the same when we were faced with the subprime mortgage crisis of 2007. Financial crises always come with concealed risks, sudden apprehensions of toxic jeopardy, and doubts about the efficacy of economic and fiscal machinery made available to tackle the extraordinary challenges of the catastrophe.

One important observation I made about every financial crisis is the swift twirl and turns in bilateral currency rates. There is always a massive dollar appreciation in the early stages of a financial crisis. This can be due to dollar shortages or in some instances different countries are struck by the emerging crisis at different time intervals. Emerging markets currencies have been battered since the onset of the coronavirus pandemic; This was due to dollar scarcities, perceived safe-haven status of the dollar, and sharp losses in the value of commodities. The South African Rand lost about 32% of its value against the US dollar as it reached an all-time record low, however, the rand has recovered more than 60% of its losses and its setting its eye on the pre-covid19 levels. The CFA, a common currency used by many Francophone countries lost almost 7% but has gained back more than 80% of its losses The story is not different for other emerging market currencies like the Brazilian Real and Mexican Peso.

However, this is not the case with the Zambian Kwacha, which lost about 30% of its value to the COVID-19 pandemic and it’s still holding on to its losses. The Egyptian Pound also lost about 15% of its value to the dollar and is not seeing any respite yet in spite of recovery in crude oil prices. The Ghanaian Cedi lost about 8% of its value and hasn’t retraced a bit. The Nigerian Naira seems to be the hardest hit as it lost over 35% of its value in both its inter-bank and parallel market rates.

Obviously African and other Emerging market currencies went on a losing streak due to a sell-off in risk assets because of the complications of the coronavirus pandemic. Dollar scarcities and the safe-haven status of the US Dollar were the headlines for massive depreciation in major and floating currencies around the world. However with new supplies of US Dollar notes from the US Federal Reserve and interest rates in the US falling to zero levels; this simply implies the US Dollar has lost its rate advantage over other currencies. Consequently, there has been a sharp recovery of most currencies against the US Dollar. However, there are important questions we need to ask at this juncture which are; have we seen the bottom for African Currencies in this coronavirus times? Or is the recent recovery in emerging markets currencies a correction for the second leg of currency depreciation in African and Emerging market currencies?

Most African economies are heavily reliant on commodities and tourism and are broadly exposed to international trade conditions. This implies a correlation between African currencies and global risk assets. Even though Crude Oil prices have been stabilizing, there is still a risk of a further fall in Crude oil prices going forward which means there are further risks to a decline in African currencies. The effects of the coronavirus pandemic on growth expectations and capital valuations have been a significant devaluation of expectations on capital performance globally. These factors will eventually weigh in on Emerging Market assets and could ignite the second round of a sell-off in African currencies.

One of the biggest risks to African currencies is the re-emergence of the US-China trade war. The frail ceasefire between the US and China on the trade front is been challenged by bickering from both sides and it includes blames on the coronavirus, the sovereign status of Hong Kong and there is a cold war brewing on the technology front. Obviously, the damage done by the COVID-19 economic crises is so enormous that it makes it certain that it would be too burdensome on the global economy to accommodate the effects of a trade war at this time. However, tensions are increasing daily and the risks of a continued US-China trade war are at a possible high. If global trade tensions persist and materialize it will become a burden African currencies will bear.

A likely victim of the coronavirus pandemic is The United Kingdom and European Union trade agreement. The UK and EU announced they are making little progress in reaching an agreement even though both parties have an end of year deadline to strike a Post-Brexit trade deal. The UK government has made it clear it will not seek a further extension to the negotiation with the EU. The recent developments in the UK and EU fronts are making No-Deal Brexit risks to reappear. The chances of a No-Deal Brexit have been dramatically increased in the last one week. The eventuality of a No-Deal Brexit would have a downward impact on the global economy and would cause a sell-off in risk-sensitive currencies and assets.

In financial markets, risks and volatility correlate together. The more volatile a financial asset is, the more risky the asset is said to be. Comparing the volatility of African capital market assets and currencies with other emerging markets and developed markets assets and currencies in the last ten years, assets of African markets and currencies have been more volatile when market sentiments turn negative. African currencies have been more vulnerable because the flight of funds out of African markets has been rapid to developed markets when sentiments turn sour in the global economy. In other words, African currencies are more risk-sensitive than their other brothers and sisters in emerging and developed market economies.

The coronavirus economic crisis might be the biggest crisis African countries might experience, there have been unprecedented selling of relatively risky assets of African countries like bonds and shares in African capital markets by foreign investors and the funds shipped to safer havens such as the US, Japan, and European Markets. This has caused a reduction in real money flows and holdings in most African economies.

The variation between Bond Yields and Credit Default Swaps (CDS) in the developed countries and African countries has widened largely in the last few months since the coronavirus pandemic surfaced. A Bond Yield is the cost of borrowing by governments or other bondholders as the case may be, while CDS is the cost of insuring the bonds against default. The widening in Bond Yields and the increase in CDS shows investors believe that African government debts are more prone to default. Widening Bond Yields have a consistently negative impact on local currencies. The spiky sell-off in African currencies is a consequence of foreign investors shipping out their funds.

However since weakness in African countries was not country-specific issues, but were due to detrimental measures that accompanied the coronavirus pandemic, the weakness in African currencies would be minimal going forward and we will see some more recoveries of lost value in some cases. This is because of the low-interest rates in the US and a bond-buying program by the US Federal Reserve, which will limit the strength of the US dollar in the immediate future. The possibilities of negative rates in the US are also a gift to African currencies as this would limit the possible slide in their value. This would also incite investors to move funds from the low yielding developed markets into African markets.

African currencies will still lose some grounds but at a decelerated pace.