07 January 2021
While there can be no doubt that COVID-19 has wreaked havoc with markets across the world, and has also made trading foreign exchange difficult, we must not lose sight of the underlying factors, writes Sam Singh, Africa Strategist, at Corporate and Investment Banking, Absa.
COVID-19 has undoubtedly been a defining time in our generation's history, with effects on global economies comparable in some instances to what was experienced during the Great Depression of the 1930s. The pandemic has also recalled the economic shockwaves of the Global Financial Crisis of 2008/09. One can argue that this episode is like none seen before because it hasn’t emanated from economic factors. The pandemic is also having a broad spectrum of effects on economies and exchange rates globally.
Although global risk sentiment has been a significant driver of currency fluctuations, we would also need to consider idiosyncratic fundamentals when analysing currency movements on the continent over the past year.
Factors that influenced global risk appetite outside of the headline numbers of the COVID-19 pandemic were about fiscal and monetary stimulus measures taken to mitigate the impact of COVID-19 on economies and news about a COVID-19 vaccine and trials of drugs. Later in the year, U.S elections and impending policy implications also influenced risk appetite. Once the US elections and some of the lingering noise around it had subsided, we saw more improvement in global risk appetite and the strengthening of emerging market currencies. Of course, this also coincided with progress on COVID-19 vaccines.
Not every country has a fully flexible exchange rate regime that immediately responds to market forces. In countries where a Central Bank does not intervene too much in the foreign exchange (FX) market, the impact on these currencies emanating from shifts in sentiment had been seen sooner than in countries with more managed regimes.
In some countries where there has been limited movement in currencies initially, we have still seen the effects of the pandemic on the overall balance of payments through a decline in FX reserves or some form of market dislocation. Export volumes had been reduced significantly due to lack of global demand; there wasn't much new investment inflows and those countries that have liquid fixed income markets had also seen portfolio outflows.
Harder hit are those countries that are heavily reliant on a single commodity although it has not always reflected in the prevailing currency values. When the pandemic first hit, many countries were aware that there would be a large impact on the balance of payments and were bracing for the worst to happen. Some central banks, seeing these rapid shifts, acted quickly to limit the consequences, and not always in conventional ways as policymakers had to tussle with stimulating economic growth but also maintain a decent FX reserve buffer due to the uncertainty and duration of COVID-19.
Despite some interventions in the FX market from some central banks, most currencies across Africa have depreciated. Naturally, as a result of weaker currencies, we have seen an impact on trade. Usually, weaker exchange rates would improve export performance, but not in an environment where there is also very little global growth and demand for a large number of goods and services. For example, weaker exchange rates have certainly not increased in tourists on the continent for the many countries’ that rely on large foreign exchange earnings. Additionally, commodity-rich countries that do not have a diversified export base were not only unable to export their products due to low demand but also saw reduced investments and portfolio outflows to safe havens.
The opening up of borders, optimism around global growth and encouragement from vaccine developments should start to improve African countries' overall balance of payments and their currency performance.
There are many reasons to be optimistic about improvements in FX markets across the continent, including the fact that many central banks are becoming more prudent and transparent when it comes to interventions that affect currencies and are improving access to foreign exchange. Countries that are negotiating financing facilities from International Financial Institutions have also sought FX reforms. This is not to say that exchange rates won't fluctuate widely in some cases or be more stable than one would expect in others: there are also idiosyncratic factors to consider during a severe global downturn, in this case, the COVID-19 pandemic.