African Tale of Two Currencies Puts Euro on Top

A trader changes dollars with naira in Lagos, Nigeria. The dollar’s long rally has had a significant effect on some African countries that are now burning through reserves and using capital controls to maintain their currency peg. Photo: Reuters

Success for African businesses depends on which currency they are pegged to

The success of Jean-Louis Menudier’s business in Ivory Coast is tied to the European Central Bank, but for Funsho Peters in Nigeria, the U.S. Federal Reserve is key.

At the moment, it is Mr. Menudier who is doing best from the ties.

Many African countries are affected by the monetary policy of central banks thousands of miles away because their currencies are pegged to either the euro or the dollar.

Economists believe that the Fed will raise rates and the ECB will continue to cut, in moves that could boost the dollar and hit the euro respectively. Many African businesses are waiting to see what the central banks will do this year.

The dollar’s long rally has had a significant effect on countries from Angola to Nigeria, which are now burning through reserves and using capital controls to maintain their currency peg.

The relative strength of the greenback is particularly key because commodities—the continent’s primary export—are dollar denominated.

Conversely, rounds of European Central Bank monetary stimulus have done little to revive the eurozone’s moribund economy, but they have kept a cap on the euro—good news for the 14 African countries that track the currency.

In Ivory Coast, one of those countries, Mr. Menudier’s textile business has benefited from the common currency’s two-year decline against the dollar.

“With the weak dollar in the past it was very difficult for us because [Asian competitors] were really very cheap,” he said. “Now, with the euro coming back close to the U.S. dollar, it’s better for us.”

Ivory Coast is part of a 14-nation African currency zone split into two different monetary unions. Each zone has its own central bank but both use a currency, the CFA franc, that is pegged to the euro.

Due to a colonial-era link, the French Treasury guarantees that these currencies are convertible into the euro. This means the countries’ central banks don’t need to burn through reserves to maintain the peg, unlike their African peers that fix their exchange rate to the dollar.

ENLARGE

In recent years, that euro peg has worked well for these countries. Since 2014, the euro has fallen about 20% against the dollar on the back of a stronger U.S. economy and the expectations of higher rates that strength has brought. The euro’s weakness has made the countries’ exports more competitive.

The franc currency zone’s biggest commodity exports, like cocoa and gold, have also fared better than oil, which is a bigger export for the African nations that are pegged to the dollar.

Gross domestic product in CFA franc countries grew by 4.4% in 2015 and 5.5% in 2014, according to the World Bank. That compares with 3.4% in 2015 and 4.6% in 2014 for most other sub-Saharan countries, many of which benchmark their currency against the dollar.

To stop their currencies falling, the central banks in these sub-Saharan countries have burned through their dollar reserves and imposed capital controls. Nigeria’s reserves have fallen 23.4% to $27.4 billion in April, since December 2014.

Capital controls put in place to keep dollars in Nigeria are making it harder for Mr. Peters to pay his staff on time. His tourism website, run from Lagos, pays freelancers across Africa. Currently, he needs about a week to process even small payments of about $2,000.

“It’s just one of those things you have to deal with when doing business in Africa,” he said.

Still, while the euro has proven to be a winning horse in recent years, economies with dollar-linked currencies have outperformed over a longer period, according to a study by the International Monetary Fund.

In one measure, per capita income in the West African Economic and Monetary Union, one of the two franc zones, increased from $805 in 1990 to $1,401 in 2013, according to IMF data. It more than doubled in a sub-Saharan peer group from $765 in 1990 to $2,003 in 2013.

Some economists say one of the reasons is that the countries in the franc currency zones have lost a lot of control over their economic and monetary policy by tying themselves to the euro. To guarantee that the franc will convert into euros, countries have to deposit half of their foreign currency reserves with the French Treasury and give up control over policy, including the size of the deficit that they can run.

But the greenback isn’t expected to weaken soon—good news for currencies tied to the euro and competing in a world dominated by dollars.

On Thursday, better-than-expected U.S. employment data bolstered prospects of faster rate increases by the Fed. Also Thursday, ECB President Mario Draghi reopened the door to fresh interest-rate cuts. Higher rates will typically attract money into a region or country, pushing up the value of its currency.

That is making many African executives regret their countries’ links with the dollar.

Nigeria’s Naira “is struggling against the U.S. dollar,” said Mr. Peters. “I think many Nigerians will agree it is time to start looking at other currencies as an alternative.”

Source: http://www.wsj.com