In the past 10 years, major economies in Africa have all been growing at 4 percent or higher per year. This growth has been fueled by the growing African businesses, but these businesses are now increasingly facing a new challenge of managing the risk created by the volatility in major African currencies.
For example the currency of Africa’s largest economy, the Nigerian Naira lost almost 98 percent value since the start of 2015 but has stabilized in recent months. Similarly, the South African Rand has fluctuated almost 19 percent over the last 1 year.
This volatility has affected major manufacturers, exporter/importers & prices of goods for average working people in African countries.
Akin from ForexTrading.ng, a Nigerian Forex education website shared ways to understand the forex market & how it affects the African businesses.
Imports are taking the hit
Most African economies rely on major imports from outside Africa like agricultural/food imports, electrical machinery, electronic goods, vehicles & more. The lower value of African currencies against USD, CNY & EUR makes these imports more expensive, hence making the end prices of imported goods expensive for consumers.
Let’s use an example of Nigerian agriculture imports to illustrate this concept. The agriculture imports include daily food items like wheat, rice, sugar and raw materials (seeds, equipment, fertilizers,etc.). Consider a raw material, say fertilizer for example, whose price is $10 in the US, has to be imported to Nigeria.
Suppose the exchange rate is 360 Nigerian Naira (NGN) to the US dollar. For the moment, ignore the shipping and transaction costs, the $10 item would cost the Nigerian importer 3600 NGN. Now, if the value of Naira depreciates against the US Dollar to 396, assuming that the price of fertilizer remains unchanged ($10), its price for the Nigerian importer would increase to 3960 NGN ($10 x 396). This would, in the end, put pressure on the Nigerian farmers as they will have to now pay more for the same Fertilizer to the importer. Also, the prices of farm outputs would also increase for the end consumers.
This simple 10 percent decrease in value of NGN vs US Dollar might have a drastic impact on businesses in the Nigerian market on a larger scale.
Good times for exports
African countries mainly export Raw materials like Oil, Gold, Copper etc. The agricultural exports of West African countries include cashew, almonds, cocoa & livestock.
Consider a food exporter in Nigeria whose primary market is the US. In usual case, the exporter will earn 3600 NGN by selling the food item for $10 in the US market (by ignoring shipping and other costs and assuming an exchange rate of 360 NGN to the dollar). Now, if the Naira weakens to 396 vs. the dollar, the exporter can now sell the food item for $9.09 to receive the same amount of Naira (3600). This 10 percent depreciation in the Naira vs. US Dollar will hence improve the competitiveness of Nigerian exporters in the US market.
The lower prices of African currencies have directly increased the profits of many Agricultural exporters in West Africa & have also increased their competitiveness on global commodity markets. In a bigger picture, higher exports by African businesses increase the dollar reserves of the African countries. This will, in turn, strengthen the local economies if all the countries become more export-oriented & balance of exports minus import is positive.
Impact on foreign direct investments
Major African countries i.e. Nigeria, Kenya & South Africa have been attracting major investments from China, Europe & United States in the core sectors: power, construction & banking. The FinTech sector in the East & West Africa is also attracting quite some attention from Foreign investors in the last 2-3 years.
But this investment has been slowing down in the past few years due to lack of profitability, and risks of price volatility for the investors.
In principle, weaker African currencies should attract more foreign direct investors in the African economies, since the foreign investors will now have more in local investments for each invested dollar.
But in reality, high volatility in currency prices & lack of availability of forex reserves for remittance is a major risk for some foreign investors since these risks can wipe out any gains.
Weaker currencies are likely to bring positive outcomes for investors betting on export sectors like Oil, Agriculture exports etc. So this is bringing huge investments from companies that are looking to invest in Raw minerals, mining in Africa.
But investors who are investing in local businesses that serve the needs of average consumers in Africa like the local E-commerce, retail sectors are facing biggest challenges due to unstable currency prices, because as the currency becomes volatile, the purchasing power of average consumers becomes unpredictable.
Managing the risk(s)
Over the last few years, the degree at which the exchange rates of African currencies change has posed a major threat for small and medium-sized businesses in Africa. This is particularly applicable for companies that engage in cross-border trades such as exports and imports.
The exchange rate has a significant effect on the trade & local economy. But these measures could help.
Focusing more on exports
One of the best ways forward for African businesses & investors to manage this risk is to focus on Exports. Higher exports would bring more foreign reserves for the African countries, create more local jobs & also boost the local economy as well.
Overall, this will make the African currencies stronger against the other major currencies like USD & EUR.
Hedging risk with currency swap
African governments can protect its local businesses from currency risks by engaging in Currency swap agreements with other countries with which they mainly trade.
Forward contracts for businesses
The ‘forward contract’ is a popular hedging strategy used by global businesses that allow them to set their prices with a budget in mind. This is a sort of a contract between the buyer & the seller.
For example, it can be an agreement where the seller agrees to sell a commodity to the buyer at a fixed price in the future. Businesses can also sign a forward contract with the bank which will enable them to buy or sell the currency (or asset) at a specified price in the future, the pricing of which is decided today. This will protect the business from any risk that may arise from a change in the value of the currency.
One way for small businesses to achieve control over unstable currencies is by opening a domiciliary account in your home country. With this account, the businesses can save your money in global currencies like USD without losing its value.
It is recommended for small businesses that deal with imports and exports to open this account as it lets you use the foreign currencies such as dollars, Euros, and pounds, and allows you to do international transactions swiftly. In Nigeria, one can open two types of domiciliary account: savings and current. You can save and withdraw any foreign currency, and use it for making international payments.
In the end
Not only African bankers or big businesses, but even a small business owner should be concerned about currency exchange rates. It is imperative to reckon the potential currency risk and adopt the trade practices accordingly so that business can deal with abrupt changes in currency values. There is no sure-shot solution to completely mitigate the effect of currency risk.
However, careful planning and implementation of correct strategies might reduce the impact of the risk to a great extent. By adopting any of the above-mentioned strategies, you can most likely reduce the currency risk. Always identify your currency exposure, measure the risk, understand your options, lock in a hedge for certainty and don’t fuss over short-term ups and downs in the currency market.