US interest rate hike is bad news for Nigeria, South Africa

The US Federal Reserves Wednesday raised interest rates a quarter-percentage point, ending nearly a decade of government intervention in the financial markets which began amid the worst financial crisis since 1929. While it signals increased confidence in the US economy which is in turn expected to increase investments and make stocks rise, developing countries will be hard hit.

“This action marks the end of an extraordinary seven-year period during which the federal funds rate was held near zero to support the recovery of the economy from the worst financial crisis and recession since the Great Depression,” said Janet Yellen, chair of the Federal Reserve at a press conference. She noted that the US economy has “come a long way” and admitted that normalization was likely to proceed gradually. While it seemed a good move to many, several others have denounced the move, including Democratic Presidential Candidate Bernie Sanders. Discussions are still ongoing on how the decision affects the American economy and Americans.

The effect of the interest rates hike will be felt in Africa, and the continent’s top two economies are vulnerable.

Nigeria

Nigeria has been hit by the fall in global oil prices as oil accounts for over 85 percent of the country’s revenue. Oil prices have fallen to below $40 a barrel from over $115 in June 2014. The country is, therefore, considering issuing international debt early next year to stimulate the economy as President Muhammadu Buhari presents the 2016 budget to lawmakers on Dec. 22. The country plans to borrow 1.84 trillion naira, about two-third of which will be local debt and also boost non-oil revenue by 1.6 trillion naira in 2016. These are expected to make up for the shortfall in oil revenue. Nigeria’s 2016 budget is predicated on an oil price of $38 per barrel but with Iran expected to pump more oil next year and the United States lifting a 40-year ban on exports, prices may not recover in 2016 and oil may well sell below Nigeria’s benchmark price.


source: tradingeconomics.com

Africa’s largest economy has other worries, the overall economic situation is taking a toll on its currency. Nigeria’s naira depreciated to N270 to a dollar at the parallel market, yesterday, as the central bank reduced dollar sales to bureaux de change (BDCs). The apex bank has tried its best over the past year to stabilize the currency using a variety of measures. However, falling foreign reserves coupled with the US Fed’s recent decision spells more doom for the naira.

The central bank has struggled for months to satisfy legitimate dollar demand in the country as it tries its best to hold the value of the naira. But market forces seemed to have pushed the bank to the limits and a devaluation of the currency seem imminent. As things stand, there is a huge disparity between the official exchange rate and the parallel market rate. There seems to be no way out for the naira.

Nigeria, like other developing countries will witness massive outflow of capital as investors move their money to the US where more returns can be made on investments, and the naira will come under more pressure. The country’s dollar-denominated debt also becomes more difficult to offset.

Although economies with strong macro and structural fundamentals would have greater resilience at this time, but Nigeria’s economic troubles before the interest rates increase did not give the country ample time to prepare for any shocks that may result from the Fed’s decision. 2016 will be tough for Nigerians and the government knows this. Efforts are being made to address the country’s challenges, but with the US interest rates hike, Nigeria’s defence of its economy just got harder.

South Africa

More vulnerable than Nigeria is South Africa. The South African rand has endured torrid times in recent times, falling by more than 30 percent so far this year. Slump in commodities prices, political pressures, labour issues and prospect of a U.S. rate hike, have slowed the most advanced economy in Africa, with several investors moving their assets abroad.


source: tradingeconomics.com

Although the currency gained a few points following the appointment of a new finance minister to correct President Jacob Zuma’s last week’s ‘mistake‘, the economy of South Africa is still in disarray. Just Tuesday, Moody’s Investment Service  cut its outlook on South Africa to “negative” from “stable”. Earlier, Fitch had downgraded South Africa’s credit rating to BBB-, while Standard & Poor’s changed the outlook on its BBB- rating to negative from stable.

South Africa’s 48 percent debt-to-GDP ratio would, ordinarily spell more doom but there is a silver lining for South Africa; most of its debt are in local currency. Besides, U.S. Federal Reserves’s assurance that the interest rate hike would be gradual may well minimize its effects.

Others

In anticipation of U.S. interest rates hike, desperate measures could be noticed across Africa, with central banks raising interest rates to shore up their currencies, reduce capital flight and fight inflation, at a time when Economics teaches interest should be cut to address drag caused by slump in commodity prices. Despite this, some economies on the continent will still suffer. Angola has devalued its currency twice in 2015 but if faces further decline upon U.S. interest rates hike. Ghana, whose debt-to-GDP level was 71 percent in June has much of its debt is in the form of short-term, dollar-denominated bonds. To pay back now that the currency is sure to fall even further, will be a struggle for Ghana.

The U.S. Federal Reserves decision is not totally a bad news for everyone. Top exporting countries can earn more with a stronger dollar. Other countries whose economies are not commodities-based, have their currencies pegged to the dollar, or have large dollar-denominated debt will fare best in Africa.