How a strong US dollar hurts investors in Africa, globally

Spread This News

By Agencies

The current value of the United States Dollar is the strongest it has ever experienced over years which has, in turn, devalued many currencies across the globe.

For developing & low income countries, many of which lie in Africa, the rise in the value of the Dollar has upended their currencies and economies as a whole. Currently, the US is experiencing high inflation which has hit an YOY growth of 9.1% in July 2022, & causing the Federal Reserve Bank to hike interest rates, thus making the US dollar even stronger.

Unlike the US, many African countries are dealing with hyper-inflation. The Zimbabwe Finance Minister Mthuli Ncube says that about 60% of the inflation is imported (fuel, fuel & fertilizer) & due to the devaluation in currency; and the remaining 40% is caused by domestic parallel market arbitrage and indiscipline/ speculative behavior.

The Finance Minister also added that the RBZ has hiked interest rates to 200% to push up the cost of speculation domestically, because in the past Zimbabwe has had negative interest rate which was free money for speculators to borrow easily, and speculate on different assets.

However, fiscal measure taken by the Zimbabwean government don’t seem to be achieving the desired results as there is still low confidence in the Zimbabwean Dollar and high confidence in the US dollar since Zimbabwe temporarily operates a multi-currency regime, driven by the US Dollar and the Zimbabwe Dollar.

Part of the lack of confidence may stem from the fact that bank deposit interest rates have not been increased for savings accounts even after the Reserve Bank of Zimbabwe increased interest rates by 200%.

However, the finance minister points out that the Zimbabwean Dollar is the dominant currency as 60% of bank deposit are in Zimbabwe dollar and 40% are in US dollar. He added that 70% of government taxes are also paid in Zimbabwe dollar and 30% in US dollar.

Devaluing Other Currencies

The United States Dollar Index (DXY) is an indication of the value of the USD in the global market. It is calculated by comparing the US Dollar against 6 currencies. Currently, the US Dollar Index figure is 106.38 which means the dollar is stronger than these major currencies by 6.38%.

The Dollar Index does not track the Dollar strength against African currencies. But most of the African currencies have lost their value against the US Dollar, which also includes the currencies of commodity exporters like South Africa. During the last one year, the South African Rand has depreciated by nearly 10% against the US Dollar.

Rahul from South Africa’s Forex Brokers explains that the impact is much worse on the emerging market & African currencies as most of these countries are net importers of energy & food. The prices of oil & food in the global markets have cooled off a bit, after the rate hikes by the US Fed, but are still high & expected to remain high in the decade to come by many supply side analysts because of years of underinvestment & the current environment of deglobalization.

Zimbabwe is also feeling the effect of the strong US Dollar as many people now flock to the US dollar for safety which further devalues the Zimbabwe dollar. This prompted the introduction of the Gold coins by the Reserve Bank of Zimbabwe to curb the rising effects of the strong dollar on the economy and stop Zimbabweans from using the US dollar as a hedge for inflation.

These gold coins are minted in various currencies such as South African Rand, Botswana Pula, US Dollar, British Pound, and Euro.  The country’s central bank looks forward to easing the demand for foreign currency by its citizens.

The ‘mosi oa tunya’ coin named after the Victoria Falls can be converted into cash and traded internationally and it contains one troy ounce of gold and the price is determined by the international price of gold at the time of transacting. Currently one gold coin costs about $1,823.80 but changes on daily basis.

John Mangudya the Governor of the Reserve Bank of Zimbabwe says the coins will be produced on a demand basis depending on market needs. He also added that buying gold coins is as good as buying gold and that the coins will be sold locally and globally.

Some experts have criticized the introduction of gold coins saying it’s too expensive as Zimbabweans can barely afford food to eat. They argued that the cost of $1,823.80 per gold coin is too high for a common man and they would have preferred if the coins were cheaper.

It is also noteworthy that when the US dollar is strong as we are seeing today, Gold is in low demand because investors choose to invest where they can earn interest easily. However in crises situations like global recessions & uncertain macro environment, Gold outshines the US dollar as many flock to it for safety. You can say the US dollar and Gold have an inverse relationship.

Higher Cost of Imports

When the cost price is high, the implication is that the selling price will be of higher price. The increase in the cost of imports of commodities can be attributed to the disruptions in supply chain high cost of energy, and inflation in foreign exchange, among others.

When the dollar gains strength, and it’s supply is limited, the value of a currencies of net importing countries decreases. By implication, the cost of importing commodities from any foreign nation also increases.

In finance and economics, the law of supply explained the immense effect of prices on the decision of the producer and its implication on the consumer. The law of supply states that the market price decreases as the supply offered increases and vice versa.

With a higher cost of import comes a lower supply of commodities and higher prices. This is passed on to the consumers of the product and gives rise to further inflation. One of the leading factors responsible for high inflation is the increase in the cost consumption which also leads to growth in income & core inflation.

Foreign Debt Settlement

When the value of the US dollar increases, the settlement of foreign debt subsequently becomes more expensive. This is because; paying debts to foreign countries requires the exchange of currencies to settle the creditor. This condition is common in most African countries as some new African businesses raise capital overseas instead of patronizing the local capital market to raise funds. African nations also depend on foreign loans to support their economy.

For a company in Africa that takes a loan in US dollars, whenever the dollar appreciates, repayment of the loan becomes more expensive. This could cause companies to shy away from taking loans for expansion and hence affect their profitability and driving their stock price downward.

Could Spark Trade Wars

Since most vital commodities come with a price tag in US Dollars because of its reserve currency status, the strengthening of the US dollar means that the price of importing these commodities will increase if the commodities are expensive. Also, the rate of trading and implementation of foreign transactions will rise in local currency.

Countries affected by the above impacts might feel tramped upon by the US and develop a defensive mechanism. As a result of this, they start to impose huge taxes and tariffs on imports to their country.

As much as this measure is responsive to the debasing of their currency. The countries that suffer the most are the ones with low foreign currency reserves, and the ones that have a negative balance of trade i.e. who are net importers.

Investors Could See a Decline in Stock Prices

The implication of a strong dollar on the stock exchange can lead to foreign investors into pulling out of emerging economies and going back to safe assets. This has a great impact on the growth and development of the emerging markets.

Investment increases a nation’s Gross Domestic Product and National Revenue by creating more employment and growing the economy. However, seeing the devalued currency, most investor begins to start taking interest in countries with higher currency value and this affects the emerging economy.

By pulling out of the emerging countries, the total value of a company’s outstanding shares in the dollar market (market cap) is reduced and this causes a reduction in total market equity. Succinctly, strong value means foreign investors move back home to save their investment while the affected countries lose more prospective investors to the high-value economy.

Profitability of Multinational Companies Is Affected

Several multinational companies earn the majority of their revenue from countries overseas. A strong dollar will result in losses in the exchange rate which consequently reduces the income of these companies.

Most American corporations set up in other countries will need to change their profits to the US dollar which unevenly reduces the value of the currency. Aside from this, seeing that the country they are in is experiencing downturn, American companies choose to move their money back home as established in the point above.

This is yet another investment and job avenue lost to the strong dollar and increases with the number of moving corporations.       

Negative Impact overall

A strong US Dollar is generally considered bad for the rest of the world, especially the least developed countries in Africa. The most badly hurt are the countries that are dependent on imports of energy & agriculture for survival.

These times are also challenging of local investors & they need to hedge risk by devising strategies through which they can offset the adverse effect of price inflation on their trading. Doing this requires effective market strategies and efficient use of financial instruments.