By Rafiq Raji, PhD
After almost a decade of extraordinarily accommodative monetary policy, which started during and in the aftermath of the financial crisis in 2007, the US Federal Reserve (“Fed”) – the central bank of the United States – is set to start normalizing policy in December 2015. That is, raising its short-term benchmark rate to more normal levels from near zero percent since 2008. Up until late 2014, it pumped an unprecedented amount of money into the American economy over a period of six years to shock it out of a recession. This is popularly referred to as its “quantitative easing” or “QE” programme. As at the end of October 2014 when QE ended, the Fed had added as much as US$ 3.5 trillion of cheap money into its economy. A significant portion of these funds found its way into so-called Emerging Market (EM) countries where yields are relatively higher. African countries have been major beneficiaries. Eurobond issuances by some African countries were oversubscribed by as much as 16 times during this period, Zambia’s 2012 US$ 750 million issuance for instance. African countries have also sold more than US$ 8 billion of Eurobonds in each of the past two years. Hitherto lacklustre equity and fixed income markets also enjoyed frenzied interests from foreign investors. A bullish international commodities market also enabled the continent’s central banks to ensure stable exchange rates.
Since the Fed’s signaled in 2013 that it planned to start reducing the amount of bonds it buys to shore up the US economy, market participants have been gearing up for the “new normal”. The process dubbed “QE tapering” also coincided with a bearish turn in the global commodities markets as it became increasingly obvious that slowing demand in China was likely a permanent shift. Lower commodity prices have made it very difficult for key African central banks to manage their mostly US dollar-pegged exchange rates as their foreign exchange (FX) reserves dwindled. Some have adjusted better than others. Prudent ones devalued their currencies as their continued support proved futile. South Africa, which operates a free-floating exchange rate regime and relies on foreign capital flows to manage its current account deficit tightened monetary policy. The Nigerian central bank adopted FX restriction measures, albeit mostly to protect the Naira against negative market reaction to its own policies. In addition to hiking interest rates, the Kenyan central bank sought a cautionary US$ 687 million International Monetary Fund (IMF) facility and non-concessional foreign loans to beef up it FX reserves. In Uganda, the central bank is set to continue its current tightening cycle into 2016 as its currency continues to weaken and inflation remains above target.
However, recent and anticipated events in some African countries may matter more than the imminent Fed hike on 16 December. In the week ahead of the 15-16 December US Fed federal open market committee (FOMC) meeting and while still smarting from a credit ratings downgrade, South Africa’s president fired his highly regarded finance minister, Mr Nhlanhla Nene. The move was widely perceived as politically motivated and poorly received by market participants. Much more significantly, market participants couldn’t fathom the wisdom behind the appointment of an inexperienced replacement. The markets reacted sharply with the South African Rand plunging to record lows. South African bond and equity markets also reacted swiftly as it became shockingly clear to them the economy was about to take a significantly negative turn. Inflation is now set to rise even more in 2016 especially as drought-induced food price pressures accelerate even more. With electricity prices likely to increase as well, inflation expectations have been raised significantly. Thus, the Fed’s likely rate hike in December may actually now be of little concern to the South African Reserve Bank (SARB).
In Uganda, its 2016 presidential elections and El Nino effects are bigger factors. Ugandans go to the polls in February in what is reckoned to be its most competitive presidential elections yet. Foreign investors have taken precautions, packing their funds out of the country. Much more potentially damaging for the Ugandan economy, however, is the anticipated ramped-up discretionary spending by authorities ahead of the elections. In 2011, election-related spending saw Ugandan inflation rise to above 30%. In addition to reduced net foreign capital inflows, pressure on the Ugandan Shilling has been driven by the authorities’ ambitious infrastructure programme, which requires significant capital goods imports. Thus, the potential effects of the upcoming Fed hike may actually be marginal.
Irrespective of where one stands on the unorthodox policy stance of the Central Bank of Nigeria (CBN), one thing is almost certain. The expected December 2015 Fed rate hike will likely have minimal impact on its markets. This is because short-term foreign capital already left on the back of its own policies. That said, the ambitious spending programme planned for 2016 by its fiscal authorities suggest the CBN may need to ease current FX restrictions to restore investor confidence. With oil prices likely to remain low for longer, Nigeria would need foreign portfolio inflows to achieve its 2016 budget goals.
In any case, most market participants long took precautions ahead of a potential US Fed rate move that they have had at least 2 years to prepare for. As is usually the case with markets, however, some knee-jerk reaction should be expected. One’s view is that after the initial rate hike in December 2015, global market players would re-adjust their portfolios in favour of emerging and select African markets. Policy divergence between the US Fed and other key global central banks suggest there would still be ample cheap funds looking for alpha returns. Some moderation relative to the QE-induced hyper activity of recent years is nonetheless expected. This should not be surprising, however.
Views were published by BusinessDay Nigeria Newspaper on 15 Dec 2015. See link viz. http://businessdayonline.com/2015/12/domestic-factors-may-trump-us-fed-rate-hike-risks-for-key-african-economies/