In this column called “The Indicator”, we will be taking an economic or financial statistic from East Africa and breaking it down into bite-sized nuggets of knowledge for investors.
This month’s indicator figure is 5.2
5.2% is the average depreciation of East African Community national currencies against a basket of currencies in the most recent year.
What is currency depreciation?
Currency depreciation is a measure of how much a nation’s bills of legal tender reduced in value in comparison with the most stable and strongest currencies in the global currency market. This method is intended to give a clear comparison of the change in value of the currency, together with policy and other analysis.
In this case the currencies of the EAC depreciated in comparison to the US Dollar and the European Euro.
What causes currencies to go up or down respective to each other?
The position of any given country’s economy in the global markets is greatly reflected in the value of its currency. Demand for goods and services from a particular country is a large factor in the valuation of its currency. The strength and stability of a nation’s finances are strongly correlated to the rising and falling of a nation’s currency value. In addition, the perceived future actions of a country and its demand for goods and services plays a factor in the value of a currency today.
To put it another way, the current and future perceived prosperity of a country impacts the value of that country’s currency. The more people want that country’s money today and believe they will want that country’s currency in the future drives the value of that currency in comparison to other currencies.
Which EAC country has the largest and which the smallest devaluation in the past year against foreign currencies?
As measured against both the USD and the Euro, Rwanda experienced the greatest devaluation at 8.5% in the past year. Kenya showed the lowest devaluation at 1.1%, which is in line with the Kenyan Shilling’s past performance.
How does this decline in the value of the currencies in the EAC compare to other regions of the world?
Inflation is at a global low. Late last year, the Organisation for Economic Co-operation and Development (OECD) reported an inflation rate of 0.1%, the lowest reported in eight years. Larger developing nations have also been experiencing similar low rates of inflation.
Inflation in the EAC has fallen dramatically over the last five years. In the last few months of 2015, most of the EAC currencies showed a rise in inflation. Many of these rises were caused by situational or temporary factors. The long term trend of inflation falling in the EAC region is expected to continue over the next few years.
In other emerging markets recent figures show a mixed picture. India’s inflation rate fell 1.2% in 2016 and China reported an inflation rate of 2.1%, whereas Brazil and Colombia reported inflation rates of 10.5% and 7.6% respectively in 2016.
Is currency devaluation in the EAC increasing or decreasing?
Inflation in the EAC has been rising slightly, after years of decreasing. Resource shortages and monetary policy have been prominent driving factors in this rise. The OECD measure of 0.1% global inflation is based on the 20 largest economies that produce 85% of the measured global output. As we see similar trends in the developed and developing economies, it is very likely that globally inflation is low, currency devaluation is high and that this dynamic will last at least for the short term.
What can EAC countries do to increase the value of their currencies?
Progressing towards stable and strong fiscal policies help increase values of currencies, and many EAC nations are pursuing this course of action. Increasing the formal size of the economy is another tactic that can bring the transparency needed to increase global demand for a currency.
Inflation must be managed properly, as inflation dilutes the value of currencies. Sound monetary policies in the long term can prevent depreciation of currency. Borrowing and loans should be kept to a minimum by the government. Export-oriented development policies can create a higher demand for the currency on the global markets as well.
How can I learn more?
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About the authors:
David L. Ross is Managing Director of Statera Capital and US Ambassador to the Open University of Tanzania active in growing companies in Eastern and Southern Africa through primary investment, investment advisory, strategic partnerships, and executive education. Connect on LinkedIn at http://tz.linkedin.com/in/davidlross1 or at [email protected]