The risk to African currencies has increased following China’s recent devaluation of its currency, the yuan.
China unexpectedly devalued its currency in mid-August by lowering the yuan’s reference rate (i.e. the rate at which the central bank sets the currency on a daily basis and from which the currency is allowed to move by +/-2 percent against the dollar) by 1.9 percent to 6.2298:$1, marking its biggest downward shift in 2015 so far.
This move by the Chinese authorities comes amid increasing efforts to stimulate economic growth via export-led activity; this is following faltering growth rates and a fall in China’s official Purchasing Managers’ Index (PMI) – from 50.2 in June to 50.0 in July – below 50 indicates an economic contraction in firms’ purchasing activity.
Undoubtedly, the devaluation of the yuan should increase China’s export competitiveness and help to boost manufacturing and investment activity. However, with China accounting for around one-fifth of the global economy, its move to devalue the yuan sparked concern that the economy might be in worse shape than previously envisaged, resulting in a sell-off in Chinese equities. In turn, this spooked investors, causing them to ditch risky assets such as commodities.
Analysts believe these developments are bound to have an adverse impact on African economies. ‘Undoubtedly, as Africa remains a key source of raw materials for China, the China-induced slump in global commodity prices will have major implications for many African economies especially for the region’s top 10 commodity exporters to China,’ Ecobank said in a research note.
Already, commodity prices have eased, putting downward pressure on the fiscal and external positions of some economies in the region, mainly, Zambia, Ghana, Nigeria and Angola.
In particular, the prices of key base metals such as aluminium and copper – usually used in China’s construction and manufacturing sectors, which are already experiencing deep levels of overcapacity – have slowed to six-year lows, falling 19 percent and 27 percent respectively, oil prices have also dropped to a six-year low ($42 per barrel), reaching close to the level last seen during the 2008-09 financial crisis.
‘Amid weaker commodity prices and hence export receipts, economic activity in key African countries such as Nigeria, Angola and Zambia are likely to slow down in 2015, weakening business prospects,’ said Ecobank.
Moreover, the fall in commodity receipts, alongside growing signs of the US’ strengthening recovery (which has triggered a rise in capital outflows from key African economies since May 2013 as demand for US dollar-denominated assets increased) will heighten exchange rate volatility. Key countries such as Kenya and Ghana are already witnessing this trend although domestic factors are also at play.
Weaker growth in China could also reduce prospects for tourism earnings in the region, especially as China’s tourism to Africa has grown by around 45 percent per year in recent years.
Other risks to the region’s currency outlook include eurozone challenges and the looming rise in US interest rates following the end of the Federal Reserve’s QE programme in October 2014. These factors pose downside risks to the region’s capital and currency markets.
As such, China’s exchange rate policy shock is likely to increase pressure on African economies to diversify their export markets, in particular, to promote regional trade.