EuroFinance

Unprecedented economic shifts in global markets have created uncertainty across the board, fuelling currency volatility particularly in emerging market economies. Major global central banks, such as the US Fed and ECB, are turning significantly more hawkish, to ramp up their efforts to tighten monetary policy in the face of high inflation. The implication is that, as global growth slows materially, commodity prices may follow suit. Consequently, emerging market economies, in particular Sub-Saharan Africa, with high exposure and dependency on commodity exports tend to be hammered the most.  

“We expect many of the African currencies to continue to struggle in 2023. However, likely dollar weakness against major currencies should moderate the amount of downside for African currencies.” Gary Dugan, CIO at Dalma Capital Management told EuroFinance. 

This currency crunch, coupled with ongoing hard currency shortages due to dollar outflows, dwindling foreign reserves and rising inflation in Africa are creating a challenging environment for treasurers managing in-country liquidity risks.  Companies operating in Africa, both multinational and regional, are facing challenging circumstances in the preservation of value as they distribute trapped funds in local currencies. 

“Unfortunately debt servicing and debt repayments will weigh on capital flows which tends to undermine currencies. Generally higher interest rates have made debt servicing even more challenging and in 2023, Africa will have to refinance around $75bn of external borrowings that are falling due.” Dugan further said. 

FX pitfalls

Consider the Spanish explosives manufacturer, Maxam, which has presence in over 12 countries in the African continent. The company’s group treasury director, Marta de Teresa manages treasury operations across West and South Africa for a Spanish multinational and told delegates that in the past the drop in oil prices made the  repatriation of funds and financing in Angola more difficult while more recently the conflicts in the West African country, Burkina Faso has created shortages of local currency, creating further challenges. 

“We tend to face challenges while not only repatriating funds but also in maintaining a smooth supply chain during times of economic and political uncertainty in the African region” Teresa told delegates at the 2023 Effective Finance & Treasury in Africa event. 

The strength of the dollar globally over the last 12 months has put pressure on the foreign debt within Africa and has also affected the currencies in the region. “2022 has been a challenging year and 2023 is going to be no different.” said Jan Beukes, Group treasurer at the South Africa-based entertainment company, MultiChoice Group which operates in 50 African markets. 

“Expectations around the amount of  US dollars one is going to get out of the country have significantly reduced, and that’s going to impact on the overall consolidated picture of any company.” Beukes further said. 

While hedging offers suitable risk management solutions in low volatility currencies, FX hedging in African economies often encounters considerable pitfalls due to largely unpredictable dry liquidity spells when compared to more developed countries, which often makes this solution extremely expensive and unattractive. In such a scenario, how should treasury teams manage their FX exposure in Africa? 

Battling volatility

The importance of finding natural hedges to offset foreign currency exposures emerged as a plausible solution during the discussion. Beukes highlighted that Multichoice as most other corporations always aim to negotiate contracts in local currency wherever possible to reduce FX exposure.  

“There will always be some opportunities to reduce FX exposure, although limited to the markets where you do not have stringent exchange control… There’s been a lot of energy deployed at negotiating contracts in local currency rather than foreign currency… while it is  not as easy, some of those opportunities have availed themselves.” Beukes told delegates. 

Meanwhile, Maxam’s local currency exposure is quite mitigated with indexation and natural hedging as its charges are indexed to a strong currency exchange rate (in which the company makes purchases), even though it charges the equivalent value in local currency and most of its transaction expenses are in local currency. 

But the problem is that if the local currency depreciates, Central Banks generally delay authorizations to buy hard currency, and therefore, the company faces a negative impact on local PnL due to the valuation of its debts with foreign supplier and on the consolidation (which is in Euros) there is exposure due to the translation of local accounts.

Regulatory restrictions

However, treasurers acknowledged that finding natural hedges is not always possible, particularly in markets with exchange controls. Both treasurers noted that staying informed about local regulations and working closely with bank partners on the ground was critical to identifying potential solutions.

The responsibilities of African central banks extend to stabilising the domestic currency, mitigating USD speculation, and minimising dollarization within their respective economies. However, these objectives may inadvertently lead to reduced liquidity, heightened volatility, and limited market inclusion. For instance, in Kenya, funding restrictions imposed on offshore entities prevent short-term funding of less than a year, thereby impeding corporations’ ability to hedge against undesired exposure in certain instances.

Meanwhile, In March 2020, the Central Bank of Nigeria announced a temporary suspension of FX sales to Bureau de Change (BDC) operators, who are licensed to buy and sell foreign currency to the public. The CBN also suspended the allocation of FX to importers of goods classified as “not valid for forex” in order to conserve foreign reserves.

Looking ahead

In anticipation of future economic conditions, treasurers conveyed apprehension regarding the potential repercussions on local currencies, particularly within countries heavily dependent on commodity exports. Beukes underscored the notion that a worldwide deceleration in economic activity could instigate a slump in commodity prices, thereby exerting strain on local currencies. Consequently, he stressed the necessity for treasury professionals to remain vigilant of these risks and to adapt their strategies accordingly.

By staying informed, building strong relationships, and collaborating effectively both within their organisations and with external partners, treasury professionals can help ensure that their companies are well positioned to weather whatever challenges may arise.