Since the start of this year, those countries whose parliaments ratified the African Continental Free Trade Area (AfCFTA) agreement and deposited a schedule of tariffs under which 90% of goods and services are traded freely have been permitted to trade under the rules of the agreement.
According to the World Bank, if fully implemented, AfCFTA would boost Africa’s income by $450 billion by 2035, while adding $76 billion to the income of the rest of the world.
[It] will reduce dependence on the dollar by allowing payments between countries to be made in local currencies
But as anyone who has followed the fallout from the UK's exit from the European Union will know, there is rarely consensus on the value of free-trade agreements. In addition, research published by law firm Baker McKenzie and economic forecasting specialist Oxford Economics acknowledged that the agreement would unlock ‘uneven’ growth opportunities on the African continent.
The Brookings Institution published a blog earlier this year by two World Bank economists that described the mix of exchange-rate regimes across sub-regional markets as an impediment to free trade in much of Africa, resulting in substantial misalignments and growth disparities.
Their observation was that countries with stronger governance and democratic institutions and flexible exchange rate s would gain competitiveness, while less mature democracies with a higher tolerance for overvalued currencies may not derive any benefit from AfCFTA because of their weaker competitiveness.
Reduced dependence
Few economies on the continent enjoy the privilege of a freely floating exchange rate. For the others, supranational organizations are the way out of what Alex Kuptsikevich, senior financial analyst at FxPro, describes as "balkanization".
“AfCFTA’s payment platform will reduce dependence on the dollar on the continent by allowing payments between countries to be made in local currencies without conversion to third currencies,” he adds.
African currencies represent a mix of pegged and floating exchange-rate regimes, unique to each country in terms of their economic backdrop. Smaller nations that are heavily reliant on the US as a trading partner often peg their currency to the dollar to avoid wide fluctuations of their currency.
Many currencies are heavily swayed by the price of commodities. This opens up floating currencies to greater price fluctuations
However, Warren Venketas, DailyFX analyst, acknowledges that there have been failures in the past that have caused pegged currencies to float because of their inability to maintain that peg.
“Foreign exchange reserves play a key role in maintaining a currency peg, so analysts will keep a keen eye on FX reserves during the valuation process, as well as often volatile political administrations,” he explains. “The rest of Africa largely falls within the floating regime, and being a continent rich in resources, many currencies are heavily swayed by the price of commodities. This opens up floating currencies to greater price fluctuations, which can be addressed (in theory) quicker than pegged regimes because they are more flexible.”
Floating regimes require strong mandates by their central banks to uphold price stability should the local currency come under pressure. African countries often face challenges such as political instability, structural reformation and inaccurate economic data, which make floating rate regimes susceptible to extreme price volatility, in turn deterring foreign investors.
There is no consensus about which set of rules works best. Openness can attract investment but risks unwanted volatility and inflation from ‘hot’ money. Currency pegs can be valuable to attract investment and promote stability, but can be challenging to maintain.
“For all emerging markets, it is essential not to run large and sustained current account deficits,” says Adam Button, chief currency analyst at ForexLive. “For the continent in general, two of the greatest predictors of economic growth are demographics and population growth. That will be a lasting tailwind over a number of years, but in the shorter term I worry about inflation risks and instability.”
Pressures
Many of the continent’s currencies have come under pressure during the Covid-19 pandemic, and even those that have managed to bounce back from losses recently are now falling back again.
“The currencies of South Africa, Tunisia and Morocco – which are not strictly pegged to the dollar – seem to have lost their recovery momentum,” says Kuptsikevich. “A reassessment of the monetary policy outlook, the prospect of higher interest rates in the US, and a significant recovery weakening promises to turn into a new outbreak of turbulence in weaker regions.”
Also working against Africa is the slowdown in China, which reduces demand for the continent's labour and resources. In this environment, Kuptsikevich says it would not be surprising if ZAR, MAD or TND renew the lows against the dollar set before the pandemic began during the next six to 12 months.
However, when asked whether there are any African currencies that are currently undervalued or overvalued, Naeem Aslam, chief market analyst at AvaTrade takes a different view on the rand, describing it as ‘interesting’ from a valuation perspective.
“The economy has come a long way from its crisis level, and we think there are now fewer challenges for the country,” he says.
