March currency review

As war in Ukraine drags on, keeping energy and food costs high, shortages of hard currencies are causing economic problems in Africa and putting great downward pressure on the continent's currencies. 

More than half the countries suffering biggest exchange rate losses in March are African (see first table below). These countries have seen import prices increase greatly since Russia invaded Ukraine. Hard currencies, mainly US dollars, are needed to buy imports and the more they cost, the more depleted foreign exchange reserves can become. As dollars become rarer, they are even more sought-after, raising their value in relation to local currencies.

Some African countries, such as Zambia from the list below, are brave enough to let exchange rates float freely, whereas most others, including Kenya, prefer to manage them to a degree, hoping to iron out volatility and keep a lid on inflation. However, such management can be very costly in terms of hard currencies, which need to be 'sold' in exchange for local currency to hold the latter's value up - so foreign exchange reserves become even more depleted.

Furthermore, the control authorities think they have when they try to manage exchange rates is largely illusory. Any central bank intervention in markets which aims to bolster local currency values is bound to go against market sentiment (if it didn't the intervention wouldn't be needed) and lead to overvaluation. An overvalued currency is, in essence, too expensive, and it's not difficult to see why people would prefer to buy into one representing fairer value. 

Trends against overvalued currencies are made worse by the likelihood of a sudden devaluation later. As importers struggle to find dollars from official sources to bring items in to sell, they must look elsewhere. That creates an opportunity for private dealers and often a black market will emerge. Because black markets tend to offer rates reflecting market sentiment, importers must hand over more local currency for precious hard currencies than they would have to in a bank if it had dollars available. This is because conversion rates at banks are usually 'managed' (i.e. overvalued) official ones. The higher costs for importers from black market purchases are passed on to consumers and inflation rises further.

So, managing the currency value will usually fail to achieve its main objective: keeping inflation down. Unless authorities quickly free exchange rates, the negative impacts will probably just get worse. The more hard currencies are obtained from black markets rather than banks, the more illicit and official exchange rates diverge. On top of rising prices, this also presents opportunities for corruption, with those (usually political elites) who can access dollars at official rates then able to sell them on the black market for considerably more local currency than they originally paid. 

Eventually, governments and central banks realise they are in a rut of their own making and the only way out is to devalue official exchange rates. Unless the devaluation is large enough, it will not have the desired effect. If it is large enough, the other main objective of managing exchange rates (avoiding big, sudden currency movements) will also have failed.

While it is encouraging to see Kenya's central bank allowing the shilling to fall (by 8% against the euro) in March, it is not clear whether this will be enough. The black market continues to offer a 7% premium over official rates. With Kenya's central bank now forcing commercial ones to ration dollars, hard currency shortages are set to worsen. In March, Trade Minister Moses Kuria said the situation was "beyond the government's control", blaming it on insufficient local production (surely something the government should be incentivising?) and people's allegedly excessive desire for foreign goods. In reality, a freer exchange rate regime would probably do a lot to ease the issue.

In the long run, it is probably better (and certainly cheaper) to follow Zambia's path than Kenya's, and let the markets decide exchange rates. Both have their problems, of course, and the Zambian kwacha fell more than Kenya's shilling in March, but foreign exchange reserves are at healthier levels in the former, where inflation continues to fall (whereas it has nearly doubled in Kenya in the last 12 months). 

Largely for historical reasons and what are seen as the West's double standards, African leaders have generally been reluctant to condemn Russia for its aggression in Ukraine. However, the war has clearly cost many of their countries dearly - no doubt a point being made by the stream of Western leaders, including US Vice-President Kamala Harris and France's President Emanuel Macron, who have recently visited Africa to try to garner support for Kyiv. If the world was to become more united against Moscow's ruinous bullying of its neighbour, Vladimir Putin might even be forced to think again and a peace deal might be possible. An end to the war would surely enable Africa, as well as Ukraine, to begin repairing the damage it has done.

Malawi provides a good example of just how divergent exchange rates can become if central banks manage official ones even more tightly than Kenya. The Malawian kwacha is effectively pegged to the dollar, causing it to become very much overvalued (and meaning it never appears on our biggest currency losses table unless there is a devaluation). As Tom Marcham, one of ECA's intrepid International Data Researchers, discovered on a recent trip there, the official rate is USD 1 / MWK 1012, whereas rates available on the widely accessible black market are around MWK 1500 - a 33% difference! As Tom discovered, banks and hotels seem obliged to advertise at official rates, whereas numerous bureaux and small private booths offer fairer value. This causes all sorts of economic imbalances and opportunities for hedging and corruption. Tom spoke to car mechanics and tyre shop owners, among others, who said they were having trouble getting stock from international suppliers, because often dollars weren't available to pay them. At the same time, international suppliers have lost confidence in Malawi as a reliable country to deal with, so are less inclined to commit to deals. 

Only two currencies gained more than 3% against the euro in March (see table immediately above). The Ghanaian cedi's gains were largely a market correction after recent losses, but the Sri Lankan rupee's advance had real substance behind it as the country secured a USD3bn bailout from the IMF. Confidence is growing that the worst of the economic crisis might now be behind Sri Lanka - helped, incidentally, by a more market-led exchange rate regime!

Finally, here is this month's selected currency movements table: