The International Monetary Fund (IMF) has expressed concerns over the sweeping currency depreciation across sub-Saharan African, saying that the currencies have weakened against the US dollar, fanning inflationary pressures across the continent as import prices surge. The global lender noted that this was mainly driven by external factors, stressing that lower risk appetite in global markets and interest rate hikes in the United States pushed investors away from the region towards safer and higher paying US treasury bonds. According to the blog re- leased yesterday, this, togeth- er with a growth slowdown, leaves policymakers with difficult choices as they balance keeping inflation in check with a still-fragile recovery.
“As the Chart of the Week shows, the average depreciation for the region since January 2022 is about eight per cent. The extent varies by country, however. Ghana’s cedi and Sierra Leone’s leone depreciated by more than 45 per cent. “Foreign exchange earn- ings took a hit in many countries as demand for the region’s exports dropped be- cause of the economic slow- down in major economies. At the same time, high oil and food prices, partly due to Rus- sia’s war in Ukraine, pushed up import costs in 2022. “Large budget deficits have compounded the effects of these external shocks by increasing the demand for foreign exchange. About half of the countries in the region had deficits exceeding 5 per- cent of gross domestic prod- uct in 2022, putting pressure on their exchange rates. On the implication, the IMF pointed out that when currencies weakened against the US dollar, local prices rise, as much of what people buy, including essential items like food, are imported. More than two-thirds of imports are priced in US dol- lars for most countries in the region.
“A one percentage point increase in the rate of depreciation against the US dollar leads, on average, to an increase in inflation of 0.22 percentage points within the first year in the region. There is also evidence that inflation- ary pressures do not come down quickly when local cur- rencies strengthen against the US dollar. “Weaker currencies make the fight to curb inflation harder given the region’s de- pendence on imports “Weaker currencies also push up public debt. About 40 per cent of public debt is external in Sub-Saharan Af- rica and over 60 per cent of that debt is in US dollars for most countries. Since the beginning of the pandemic, exchange rate depreciations have contributed to the region’s rise in public debt by about 10 percentage points of GDP on average by end-2022, holding all else equal. Growth and inflation (which reduces the real value of existing debts) helped to contain the public debt increase to about 6 percent of GDP during the same period. “Many central banks in the region have tried to prop up their currencies by supplying foreign exchange to importers from their reserves. But with reserve buffers running low in many countries, there is little room to continue inter- vening in foreign exchange markets.
“Countries have also ap- plied administrative mea- sures such as foreign ex- change rationing or banning foreign currency transactions. These measures can be highly distortive and create opportunities for corruption. Given that the external shocks are expected to persist, countries where exchange rates are not pegged (fixed) to a currency have little choice but to let the exchange rate adjust and tighten monetary policy to fight inflation. “Countries with pegged exchange rates will need to adjust monetary policy in line with the country of the peg. In both country groups, fiscal consolidation can help to rein in external imbalances and limit the increase in debt related to currency deprecia- tion. Structural reforms can help to boost growth,” IMF said.