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Friday, January 08, 2021 / 10:03 AM / By
Vetiva Research / Header Image Credit: Forex Crunch/Ecographics
SSA Currencies: Risk-on
Stages a Comeback
2020 was clearly a turbulent year for emerging and
frontier currencies, as the pandemic incited several external sector shocks,
from subdued resource and tourism earnings to lower remittance flows.
Petrocurrencies have been the worst hit-the Angolan Kwanza (-35.9%) and the
Nigerian Naira (-9.7%)- due to insufficient external buffers and a global
risk-off sentiment that triggered the reversal of foreign capital. While the
Kwanza has been in free fall since its Oct'19 regime change, the Naira saw a
dual-devaluation in 2020 as oil prices slumped. The Naira is still largely
perceived to be overvalued because of the large divergence between the official
and parallel market rates, despite a review of its remittance policy to narrow
the FX gap.
Elsewhere, the first and second waves of lockdowns in
Europe-a key Kenyan export destination-contributed to the weakening of the
Kenyan Shilling (-7.8%), despite interventions from the Central Bank of Kenya
(CBK). Reports of a dual exchange rate system also surfaced in the country, as
the public sector's official exchange rate diverged from the rate in the
interbank window i.e., the market rate. The divergence is suggestive of a
price-discovery process in a somewhat restricted market, as the CBK's dollar
supply did not increase in tandem with demand.
Unlike the Shilling, the Gambian Dalasi (-1.3%)
absorbed external shocks thanks to strong remittance and official development
assistance (ODA) flows, that made up for the slump in re-exports. Similarly,
inflows from development partners moderated the depreciation in the Leone
(-3.7%), amid foreign currency restrictions. Meanwhile, the Ghanaian Cedi
delivered a not so surprising resilient performance, softening by a meagre 2.7%
in 2020, despite the country's Presidential election. The surge in gold prices,
recovery in cocoa prices and an early Eurobond raise provided support for the
Cedi to outperform its four-year average depreciation of 10.5%.
In South Africa, renewed global risk-on sentiment
supported the recovery in the Rand (-5.0%) from grossly undervalued levels
during selloffs in Q1'20. Higher gold prices, which lifted trade surpluses to a
three-decade high in Q3'20, also provided support to the Rand. The appreciation
of the outlier, the Liberian dollar (+13.3%) has not been driven by
fundamentals, instead being caused by an artificial scarcity of the local
currency in the highly dollarized Liberian economy.
Nigeria's FX Conundrum
Following two years of relative stability in the
Nigerian foreign exchange market, the pandemic necessitated further adjustments
in the Naira exchange rate as demand for FX built up amid constrained oil
receipts. Following an initial 18% adjustment in Mar'20 to forestall
considerable depletion in reserves, the Naira's quasi-peg was further adjusted
by 6% as a pre-condition for accessing a $1.5 billion World Bank facility.
Although the World Bank recently approved a total of $1.5 billion for social
welfare and state fiscal support, the original $1.5 billion budget support
request is still pending. True to the pre-conditions for the loan, the
government has implemented reforms in both the energy and foreign exchange
markets. However, the dollar still trades at 24% and 8% premiums in the
parallel market and I&E window respectively. This breaches the IMF's
permissible exchange rate gap of 2%; as such, the currency is still considered
overvalued. True to this, the closing 12-month forward rate reflected that the
Naira should be trading within parallel market ranges.
In Q4'20, the Naira depreciated in both the I&E
and parallel windows to ₦410.25/$ and ₦470/$
respectively driven by demand pressures from both investors and manufacturers.
In November, the parallel market rate depreciated to a resistance level of ₦500/$ which triggered a
series of circulars from the apex bank to prevent the FX gap from widening
further. The Bank had uncovered arbitrage practices perpetrated by some
International Money Transfer Operators (IMTOs). In a bid to address this, the
apex Bank reviewed its diaspora remittance policy by directing banks to credit
beneficiaries of remittances in foreign currency. This move led to a 6%
recovery in the parallel market rate.
While the policy sought to improve foreign exchange
supply in the parallel market, the benefits may not yield desirable
appreciation in the currency due to the slump in remittance receipts since the
onset of the pandemic. As of 9M'20, remittances were 66.5% lower y/y no thanks
to the pandemic-induced dent on take-home pay in advanced economies. However,
pent-up demand from manufacturers will keep demand for FX elevated at the
parallel window while weak growth outcome, rising inflationary pressures and
negative real yields keep foreign portfolio investors on the sidelines.
BoP Financing, Cheaper
Imports Strengthen Reserve Adequacy
The balance of payments (BoP) of several economies
encountered numerous pressures from the merchandise, income and transfer
segments of the current account to investment flows in the financial segment.
During times of BoP crises, countries could resort to swap lines with other
central banks, sovereign wealth fund drawdowns or multilateral financing. While
advanced and emerging markets seldomly drawdown on reserve assets, less
developed economies resort to financing from International Financial
Institutions (IFIs). Due to the low levels of intra-African trade and the
absence of international reserve currencies in Africa, African countries do not
have sufficient reserve levels to partake in credit swap lines. Only two
nations in the SSA region have more than $30 billion in external reserves - South Africa and Nigeria.
Assessing external vulnerability indicators of SSA
countries, many SSA economies have adequate reserves to fund their imports and
are less prone to externally influenced banking crises. Several SSA countries
have their import cover ratios above the global benchmark of 3 months. While
Liberia underperforms select SSA peers, the net-effect of the pandemic on its
terms of trade is positive given the overwhelming impact of cheaper fuel
imports and higher demand for metal exports. We believe the impressive import
cover metrics were supported by cheaper fuel imports (Liberia), concessional
financing (Nigeria), development financing (Sierra Leone), current account
gains from higher gold prices (South Africa & Ghana) and import
substitution efforts (Angola).
Buttressing reserve adequacy levels, the broad-money
ratio reflects how loss of confidence in domestic currency by non-residents
could affect the banking system. Countries with strong banking systems such as
South Africa, Nigeria and Kenya have healthy broad-money ratios, reflecting
solid reserve adequacy levels and ability to absorb shocks from sudden capital
withdrawals. For emphasis, we believe the strong recovery in the Rand can be
linked to the depth of its financial market.
Currency Levers in 2021:
Weaker Dollar, Tighter Monetary Stance and AfCFTA
While the currencies of oil-dependent economies
(Nigeria & Angola) remain below pre-pandemic levels, development finance
assistance supported the currencies of smaller economies (Sierra Leone &
Gambia). The currencies of diversified economies (Kenya) remain at the mercy of
further COVID-19 waves in key export destinations, despite stable remittance
inflows. With positive vaccine developments, doused health tensions could
contribute to the recovery in commodity prices in 2021, and by extension
support the currencies of resource dependent SSA economies (Kenya, Nigeria,
Ghana). However, upon the mutation of the virus, tourism-dependent economies
(Gambia) could witness currency pressures, unless official assistance from
development agencies continually serve as buffers. Countries with developed
financial markets as South Africa could witness record inflows from portfolio
investors because of the prevailing low yield environment in advanced
economies.
Following Joe Biden's election as US president, trade
tensions are expected to dissipate as the new President adopts a more
diplomatic and multilateral approach to international trade. This could help
global trade recover from the double whammy of the trade war and
pandemic-induced supply chain disruptions. Thus, we expect a recovery in
industrial demand to boost external demand for key commodity exports and
prop-up reserve levels of resource dependent SSA economies. In addition, the
kick-off of the Africa Continental Free Trade Agreement could result in
investment flows into countries with the right business environment,
pro-manufacturing incentives, strong transport networks and less bureaucratic
trade procedures. In the long run, SSA economies could insulate their reserves
from shocks and currencies from the volatilities associated with huge exposure
to foreign portfolio investments. Attracting more stable capital flows could be
essential in keeping currencies afloat in 2021.
Amid the global liquidity glut from the ultra-dovish
monetary policy stances in advanced economies, real negative yields in haven
economies could spur continuous capital inflows to emerging markets. Our base
assumption is that stimulus packages, high liquidity injections and asset
purchase programmes will be sustained in advanced economies until health risks
subside significantly. With the recent mutation in the virus, health risks
remain imminent despite positive vaccine announcements. Meanwhile, portfolio
investors will continually seek refuge in higher yielding environments. With
the anticipated increase in oil prices, non-oil economies could deliver rate
hikes to rein in inflationary pressures. Petrocurrencies may remain under
pressure until fundamentals in the global crude market improve.
SSA Currencies Outlook
With the pandemic as a key issue of concern,
petrocurrencies and gold exporters could experience divergent outcomes due to
recent developments-vaccine availability and the mutation of the virus. While
vaccine administration could provide respite for battered petrocurrencies
(Nigerian Naira & Angolan Kwanza), new strains of the virus could
strengthen currencies of gold exporters (Ghanaian Cedi & South African
Rand). In 2021, negative real returns in advanced economies would fuel
investment appetite for emerging assets providing a foothold for the Rand,
given South Africa's deep financial markets, capital mobility and floating
exchange rate regime. Resource-dependent currencies such as the Ghanaian Cedi,
Kenyan Shilling, Angolan Kwanza and the Nigerian Naira would benefit from
subdued trade tensions as demand from Asia & Europe gradually improves.
Meanwhile, aid flows and development financing will continually serve as buffer
for the Leone and Dalasi.
In addition, currency-swap arrangements could spring
up within the region to reduce dollar dominance, especially as the AfCFTA kicks
off. Before the pandemic struck, a currency swap deal between Nigeria and
Sierra Leone was in the works, as Sierra Leone intended to capitalize on the
former's currency swap deal with China. We could see a revival of such currency
swap deals to reduce dollar dominance and facilitate bilateral trade
arrangements. Should African countries take this route, improved intra-continental
trade in African currencies could ease currency pressures.
Drilling down on the Naira, the presence of multiple
unfavourable macroeconomic factors could exert pressure on the currency. Given
the existence of multiple exchange rates, rising inflation and low yielding
money market instruments, the Naira could undergo severe pressures if
fundamentals in the oil market do not improve. Higher oil prices could enable
the country raise funds from the international debt market. In the meantime,
inflow from the World Bank is expected to support the CBN's fire power in
defending the currency.
According to a Consumer Expectation Survey report
conducted by the CBN, consumers expect the Naira to appreciate in 2021. While
improved market fundamentals may lead to improved foreign exchange supply, it
is highly unlikely that the official exchange rate will be revalued. We believe
at best, there could be a narrowing of the foreign exchange gap which could be
driven by further adjustment in the official exchange rate or risk-on
sentiments by portfolio investors incident upon oil price recovery and a
possible reversal in the yield environment.
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