With the world searching for alternatives to the US dollar and finding them more often, countries should utilise this window of opportunity to de-dollarise African trade to strengthen local currencies.
- The US dollar has risen rapidly after the Federal Reserve decided to raise policy rates for longer to control stubbornly high inflation.
- The crystal ball that foretold an ultimate conglomeration of African currencies into a single medium of exchange and store of value has now received some attention.
- The decreased dependence on the US dollar in African trade will help raise the value of the local currencies.
A stronger US dollar has hurt Africa’s economic and trading activity
The US dollar has risen rapidly after the Federal Reserve decided to raise policy rates for longer to control stubbornly high inflation. This move has had far-reaching effects. The US dollar is popularly utilised globally as the international medium of exchange and as a reserve currency.
The dollar is strengthening, with Africa already grappling with rising inflation triggered by a flurry of economic shocks. As dollar power increases, it amplifies inflationary pressures across the continent. Consequently, central banks find it somewhat challenging to tame high inflation.
Additionally, a rising dollar has squeezed trade volumes, resulting in tighter trade financing conditions, burgeoning sovereign debts, and surging debt-servicing costs.
As the dollar gains strength, it drags on Africa’s economic activity, pressuring other currencies to weaken and fueling even higher dollar strength due to a surge in demand for the green buck. Unfortunately, African nations have few options to counter the strong dollar, with the available ones mainly challenging.
Consequently, nations have tried raising interest rates to tackle currency depreciation pressures from the strong dollar. But, in doing so, policymakers face a tricky balancing act. Lifting rates need careful calibration to avoid spurring an economic downturn.
The alternative has been to contain currency depreciation pressures by intervening in the monetary market by injecting foreign exchange dollars into the market reserves. The impact of this intervention is that a number of African countries have seen their surplus reserves depleted after large pandemic-spurred public spending support programmes and more expensive payments on commodity imports.
READ MORE: Africa’s economies to defy pandemic, perform well in 2022/23
Leveraging PAPSS to de-dollarise African trade
The crystal ball that foretold an ultimate conglomeration of African currencies into a single medium of exchange and store of value has now received some attention. On January 13 2022, Afreximbank commercially launched an African Union-backed Pan-African Payment and Settlement System (PAPSS).
The interoperability of the PAPSS Platform mainly focuses on promoting trade within the continent. With the African Continental Free Trade Area (AFCFTA), with a market value of $3 trillion, there is room for African countries to leverage the system to raise the demand for their local products and services. Consequently, the rise in export power will strengthen their respective currencies.
The PAPSS represents a significant milestone in connecting African markets seamlessly. The system provides an additional impetus for businesses to scale more easily across the continent. Making the process more effective and seamless will save Africa more than $5 billion in transaction costs annually.
The AfCFTA, the largest trading bloc since the creation of the World Trade Organisation (WTO), is expected to increase intra-Africa trade and improve the prospects of the African continent to attract huge investments. The goal of a common currency in Africa has long remained a pillar of the AU, a symbol of the strength that its proponents hope will emerge from efforts to integrate the continent.
Under the AfCFTA, liberalisation and de-dollarisation of trade will happen through regional trading blocs. These blocs include the East African Community (EAC), Southern African Development Community (SADC), Common Market for Eastern and Southern Africa (COMESA), and the Economic Community of West African States (ECOWAS) — which run separate Customs unions.
Lower dependence on the US dollar boosts local currencies
The decreased dependence on the US dollar in African trade will help raise the value of the local currencies. Previously, experts estimated that over 80 per cent of cross-border payments in Africa were re-routed offshore for clearing and settlements. This process increased the turnaround time for concluding intra-African transactions and drastically reduced customer satisfaction.
This is the main challenge that Small, Medium Enterprises (SMEs) on the continent have had to confront. Suppose one wants to trade between South Africa and Kenya. In that case, they have to exchange the South African Rand for the US dollar, transact with the Kenyan business which receives that US dollar, convert it into the Kenyan Shillings and then conclude the transaction. The process is unnecessarily costly and slow.
The overreliance on foreign currencies costs Africa over $5 billion in transaction costs annually. De-dollarisation bridges the gap in the erstwhile fragmented payments system that has long existed in the continent. This offers a renewed opportunity to deepen African trade. The opportunity here is for African countries to raise the percentage of their trade from 15 to 35 per cent within the next five years.
Less dependence on the US dollar is a welcome move to facilitate trade and the domestication of the currency of African nations. It is the first step in achieving a common currency within the region. Indeed, this laudable journey has started, if only at a minimal level. Consequently, African nations must move quickly to consummate the gains and possibilities of this significant move in a bid to de-dollarise African trade.
The dominance of the US dollar is slowly coming to an end
The question of when a global reserve currency starts or ends is not an exact science. There are neither press releases announcing it nor big international conferences ending with treaties signing and a photo shoot. Nevertheless, any global reserve currency’s historical reign has to end at some point.
Central banks and governments have always known that the dollar has a sell-by date as the global reserve currency. However, the matter has not been discussed openly until now. The fact that the issue has remained on the radar of powerful banks for years should give one pause.
Issues regarding the global reserve currency rarely make it to daily mainstream media discussions. Most mainstream economists avoid topics like the plague. The issue is too politically charged. However, that does not make it any less important for investors to look for answers.
There appears to be a consensus that the world is finally turning its back on the US dollar. There are simmering shifts within the global monetary system. The shift becomes ever more apparent, best described as de-dollarisation.
The world is searching for alternatives to the US dollar, finding them more often. Thus, moving away from the dollar can no longer be stopped. For instance, early this year, Indonesia reiterated it would promote local currency settlement (LCS) in cross-border trade and investment to reduce dependence on the US dollar.
According to Indonesian Finance Minister Sri Mulyani Indrawati, governments can implement LCS more comprehensively globally. This could create a financial safety net among countries and reduce the risks caused by global economic and financial instability. Countries should utilise this window of opportunity to de-dollarise African trade to strengthen local currencies.
READ MORE: Shift from the dollar with Pan-African Payment System launch