Currency Conundrums: Volatile African Exchange Rates and What Can Be Done

Written by: Isha Doshi 
TLG Capital is an investment firm that has been investing in SMEs (small and medium sized enterprises) across sub-Saharan Africa for over a decade. We have experienced first-hand how currency volatility across the continent can pose a significant challenge, both for international investors and the economies themselves. 

While opportunities abound across the continent, the erratic nature of exchange rates can undermine potential returns and create financial instability. This creates a vicious cycle: fluctuating (usually downward) exchange rates are both a symptom and a cause of deeper issues such as underdevelopment, capital flight, and inflation.

A case in point is the recent devaluation experienced in Nigeria, Africa’s most populous nation. In October 2022, the official exchange rate in Nigeria (Nigerian Naira per USD) was approximately 430 NGN per USD.​ This month the market rate hovers around 1700 NGN per USD​. 

Next door in Ghana, the situation has been equally challenging. In 2022 alone, the cedi depreciated by nearly 54% against the USD, a significant factor that led the country to default on its sovereign debt in December of that year.

Moving East, currencies are more stable. Still, in 2023, the Kenyan shilling depreciated by about 15% against the USD. 

By contrast, other countries in sub-Saharan Africa have maintained relatively stable exchange rates. The Djiboutian Franc is pegged to the dollar while the Botswana Pula, known for its “annual downward crawl” (a planned annual depreciation), is pegged to a basket of currencies.  The CFA franc, meanwhile, is used by 14 countries in West and Central Africa and is pegged to the Euro.

Out of the approximately 46 countries in the sub-Saharan African region, only a few maintain fully free-floating exchange rate regimes. South Africa and Uganda are notable examples. The majority of countries either peg their currencies or adopt a form of managed float regime (Nigeria, Ghana, Kenya).

Pegged regimes do anchor inflation expectations. This is particularly true when the peg is backed by credible monetary commitment. For example, the CFA franc, pegged to the euro, is guaranteed by the French treasury, and has helped its member countries maintain lower inflation and financial stability than their peers. The related trade-off is lost policy flexibility  – not ideal but arguably should be borne until economic fundamentals improve. 

Exchange rate stability is appropriately perceived by many policy makers as an integral factor to managing economic fragility.

The diagram below illustrates a typical cycle of exchange rate depreciation, highlighting the difficulties which many developing African countries face. 

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A critical issue is the fact that most sub-Saharan African countries (South Africa, Namibia and Botswana are notable exceptions) are net importers. Significantly, staple goods (essentials such as rice, wheat and maize) tend to be imported. 

Over reliance on imported goods creates economic vulnerability as global shocks (the Ukraine War, COVID -19) can lead to increased costs of living. Maintaining large foreign reserves to pay for these imports further depreciates the currency.

Trade imbalances across the continent are often coupled with a dependence on Eurobonds (borrowing in foreign currencies), also exacerbating currency devaluation. When local currencies weaken, the cost of servicing foreign debt increases, creating a vicious cycle of exchange rate devaluation. In Ghana over the past two years, a devaluing cedi meant that servicing debt in foreign currency became increasingly expensive. 

Another issue is that countries across the region are primarily commodity exporters. Large movements in commodity prices can cause trade imbalances, in turn causing foreign exchange flows to vary. 

One solution international investors use is to open hard currency deposit accounts with local financial institutions. The deposits can be used as collateral and borrowed against in local currency which is then used to invest. However, legal measures in different countries mean this solution may not always work.

The international community has also helped allay risk for international investors. Organizations like the Development Finance Corporation, MFX and TCX Currency Solutions and the Medical Credit Fund provide either guarantees or discounted hedging solutions to investors. While not a long-term solution, these institutions do offer some protection and therefore encourage a flow of capital to the continent which would presumably not occur otherwise.

Another way to support strong African companies is to encourage the set-up of local fund managers for pensions to invest in. Currently, pension funds across the continent often invest the majority of their capital in local T-bills. New funds would help provide a larger set of investment opportunities (with enhanced yields) while directing local monies to viable local businesses.

TLG champions this “local solutions” concept by partnering with local fund managers – sharing its credit investing know-how to serve SMEs in country. Earlier this year, the FCMB-TLG Credit Fund reached its first close in Nigeria, notable as it is the first local currency credit fund in the country with its first close oversubscribed by multiple local pension funds.

Policy-wise, there are also solutions. For example, central banks could provide hedge guarantees to international investors – aiming to remove extreme exchange rate risk to encourage foreign investment. Such a hedge could be focused at particular sectors that are seen as strategically important, such as SMEs or agri-businesses.

Several attempts at currency unions have been made (for example, the West African Monetary Zone (WASMZ) or the East African Community single currency goal), but they face hurdles. Issues include diverging economies, fears that the union could collapse in times of economic adversity, and worries about asymmetry where more powerful or large economies dominate to the detriment of their smaller neighbors. 

More successful have been regional payment systems – alleviating intra-African exchange rate volatility and risk by enabling transactions in local currencies and simultaneously reducing dependence on external currencies. For example, the East African Payments System (EAPS) allows real-time cross-border payments in local currencies among EAC members both minimizing exchange rate fluctuations as well as transaction costs.

Ultimately, exchange rates volatility will settle when key sectors (agriculture, local manufacturing, technology, and services) develop. Access to affordable reliable electricity, adult literacy and health and mortality outcomes are key. Supporting SMEs (proven engines of economic growth across all economies historically) across the region will be critical for success.
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About the Author

Isha Doshi – Isha is co-founding partner and CFO of TLG Capital. She has led structuring for 41 transactions across 20 African countries amounting to more than $230m of investment facilities since 2009. Prior to TLG, she worked on the fund derivatives structuring desk at Lehman Brothers. She holds a Masters in International History at The London School of Economics (LSE) and a Bachelors in Mathematics and Economics from Columbia University.





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