As the Federal Reserve hikes interest rates at a rate not seen in over 40 years, it’s largely been developing economies that have borne the full brunt of an increasingly contractionary monetary policy. Since the Fed commenced its short-term interest rate increases in March of last year, the average African currency has starkly depreciated relative to the dollar, with exchange rates with the USD sliding to new lows.
Writing on the topic, the IMF reports that “the depreciations across the region were mostly driven by external factors. Lower risk appetite in global markets and interest rate hikes in the United States pushed investors away from the region and towards safer and higher paying US treasury bonds.” Of course, while the burden of causation shouldn’t solely rest with the US as other influential institutions such as the European Central Bank and the Bank of England continue to raise interest rates themselves, movements in US Treasury securities have reflected investors’ scrambles for safety in spite of other politics involving the asset. 10-year yields on US Treasuries have declined from 0.11% on March 18, 2022, the day after the FOMC began raising rates, to a current level of -0.55%. Although increasing the federal funds rate place upward pressure on Treasury yields in the short-term, such increases have also been accompanied by a withdrawal in liquidity in financial markets as well as instability in the banking sector, all factors that have compelled market actors to invest in safe assets such as Treasuries and thereby raising the asset’s prices and lowering its yield. Thus, even as the debt ceiling debate threatens returns on the trusted Treasury security, its continued yield in negative territory may indeed reflect cautious investing that has seen funds being drawn away from financing African economies.
Source: International Monetary Fund
With the African continent experiencing an average of 8% depreciation since January 2022, the IMF also observes that, “a 1 percentage point increase against the US Dollar leads, on average, to an increase in inflation of 0.22% points within the first year in the region.” Doing the math, this extra 1.76% buffer placing upward pressure on inflation has further made it difficult for African countries to finance critical imports such as food and oil, especially in light of external factors such as Russia’s invasion of Ukraine that have skyrocketed such costs. Meanwhile, sub-Saharan Africa currently holds a public debt that’s over 56% of its GDP, of which “exchange rate depreciations have contributed to the region’s rise in public debt by about 10% points of GDP on average by end-2022,” once more according to the IMF. Given many African countries’ large reliance on US financing of their deficits, an appreciation in the US Dollar forces such countries to face higher costs in paying them back.
With both rising inflation and public debt, it may be up to African economies to tighten both fiscal and monetary policy, perhaps even targeting their exchange rates with the US Dollar in order to limit further losses to the sheer depreciation in regional currencies. In light of a dwindling supply of foreign exchange reserves in the dollar in a number of the region’s economies, pegging the exchange rate would prove short lived as reserves would be exhausted; instead, a contractionary monetary policy could promote a cheapening in imports while tightening fiscal policy, most importantly cutting budget deficits in the first place, could stave off worrying growth in Africa’s debt-to-GDP ratio. Although the implications of a tightened policy may not be attractive for short-term African growth, it may serve as the painful medicine needed to restore long-term macroeconomic stability.