Foreign exchange markets are pivotal to the global economy, facilitating currency conversions that enable international trade, financial transactions, and investments. Africa’s foreign exchange (forex) landscape is a critical component of its economic framework, influencing both domestic stability and international trade. However, the continent faces unique challenges due to a complex mix of domestic politics and global market conditions governing its forex exchanges and respective currencies.
Africa hosts 41 different currencies, many of which are illiquid, rarely traded globally, and highly volatile, posing significant challenges for international businesses and investors. Despite efforts to balance social needs and inflation through monetary policy, countries across the region are significantly impacted by currency volatility, limited liquidity, and susceptibility to external shocks, such as fluctuations in commodity prices and changes in global financial conditions. Although Africa lags behind other developing regions in financial development indicators, it has made strides in integrating with the global economy and enhancing the resilience of its domestic capital markets.
Many transactions in Africa use an intermediary or “clearing” currency to circumvent currency inconvertibility, which increases costs and exposes businesses to additional currency risks. While the volume of US dollar transactions remains high, there is a steady increase in regional currency transactions, facilitated by technological advancements, especially the rise of Fintech, and pan-regional collaboration, easing trade flows across Africa, notes Karim Anjarwalla, Director at ALN.
Innovative Interventions by African Economies
To address local currency challenges and stabilise the forex market, collaboration with local African banks is crucial. Enhancing compliance procedures to align with international standards is a key strategy.
Technological advancements in FX trading and the growth of Fintech are paving the way for innovative solutions, offering access to a broader spectrum of currency pairs and real-time market data, which in turn enhances liquidity and competitiveness within local currency markets, according to Sonal Tejpar, Partner at Anjarwalla & Khanna (ALN firm in Kenya).
Several African countries are implementing measures to strengthen their currencies and improve the business landscape,
1. Nigeria
The Central Bank announced a USD 10 billion injection of foreign exchange into the market, sourced primarily from crude oil sales and foreign investments. This is intended to settle foreign exchange debts previously constrained by limits on forex usage.
2. Ghana
Implemented a “gold for oil” policy in late 2022, using gold instead of cash to purchase oil, reducing pressure on the weak Ghanaian cedi and bringing in cheaper fuel. This scheme has saved approximately USD 5 billion in foreign reserves.
3. Egypt
Proposed a barter agreement with Kenya, exchanging goods directly for tea to conserve foreign reserves and reduce reliance on the US dollar.
4. Zambia
The Central Bank plans to increase foreign currency deposits required of banks, aiming to build up forex reserves and support the local kwacha currency.
Importance of Pan-African Initiatives in Shaping the Foreign Exchange Landscape
The African Continental Free Trade Area (AfCFTA) agreement, effective since 2021, aims to lower trade barriers, boost commerce, attract foreign direct investment, and spur economic growth. Complementing AfCFTA, the Pan African Payment and Settlement System (PAPSS), a project by the AfCFTA secretariat and Cairo-based Afreximbank, aims to link African central banks, commercial banks, and fintechs into a network enabling quick and inexpensive transactions among the continent’s currencies.
According to SWIFT, only about 12 percent of intra-African payments were cleared within the continent as of 2017, with the remainder routed through overseas banks. This often necessitates converting African currencies to dollars, pounds, or euros, and then swapping them back to another African currency, adding an estimated USD 5 billion annually to transaction costs.
PAPSS aims to settle transactions in local currencies, eliminating costly overseas intermediaries and completing transactions in under two minutes at low costs, explains Jean-Eric Sauzier, Partner at BLC Robert & Associates (ALN firm in Mauritius).
For PAPSS to succeed, African central banks must reconcile differences in domestic regulations, infrastructure, and oversight systems. This initiative could significantly boost intra-African trade and transform the continent’s economic landscape.
Outlook for Africa’s Foreign Exchange
Africa’s forex landscape is a complex and dynamic element of its economic architecture. While it presents significant challenges, including volatility and regulatory fragmentation, it also offers opportunities for enhancing export competitiveness and regional integration. The impact of forex on international trade is profound, influencing export performance, import costs, and overall economic stability. As African nations continue to navigate this landscape, they must formulate strategic Pan-African policies aimed at stabilising currencies, building foreign reserves, and fostering regional cooperation, which is crucial for sustainable economic growth and development.
Sources
Brookings | IMF | The Exchange Africa | McKinsey & Company
