Europe and Africa are intrinsically linked. And one of the most fundamental links that give Europe leverage over the African continent is its monetary link. More importantly, Europe is one of the first customers and investors in African markets. Therefore, any change in European monetary policy affects African capital markets.
It was announced this Thursday that the European Central Bank raised interest rates by a quarter of a percentage point, unmoved by recent data showing a mild recession last winter in the twenty countries that use the Euro. Indeed, the European Central Bank has now hiked rates at eight consecutive meetings since July in a fight against inflation. The latest move takes the benchmark in the Eurozone to 3.5%, the highest since May 2001.
We know that African countries import more than they export, which creates a trade deficit in their balance payments. The cost of imports will increase for Africans that buy from the European market because European manufacturing companies that need to raise capital will have to raise capital at much higher interest rates. Since capital will be provided at higher interest rates, European manufacturing companies will then have to increase the price of their products to make a profit so that they could pay back their loans, and keep the remainder to either reinvest or pay their shareholders a dividend. For African countries, they will have no choice but to purchase imported goods that are overpriced, and sell these overpriced imported goods to their local populations.
Moreover, the European Central Bank raising interest rates is bad news for African entrepreneurs, especially the ones from the CFA zone. It is already extremely difficult for African entrepreneurs from the CFA zone to raise capital to start their venture since they mainly use debt financing instead of equity financing. African commercial banks are generally reluctant to lend money because the infrastructure of capital markets in the CFA zone isn’t thoroughly set.
Now that interest rates have been hiked, commercial banks will make it more difficult even for entrepreneurs with excellent credit to borrow. This means that if, for example, the French consumer wants to start a business and decides to get a loan from the bank, the bank will probably lend that money at a 5 or 6% interest rates. Since the bank in France will lend money at 5 or 6% interest rate, the bank in Africa will land that same money at, perhaps, a 9 or 10% interest rate because of the exchange rate.
Thus, the application of contractionary monetary policy by the European Central Bank will affect markets in the CFA zone. It is going to tighten the credit market in the CFA zone further. Africans from the CFA zone will be compelled to borrow less and save more. Businesses will also have to slow their operations, which could slow their economies as a whole.