Unless you really enjoy the game, you wouldn’t enter a casino knowing that you cannot cash out. Foreign investors are facing a similar deterrent across Africa: businesses in some of the continent’s largest economies are struggling to get their hands on hard currency – and are thus unable to repatriate profits.
We have seen liquidity risk – the risk that forex constraints prevent profit repatriation and the funding of imports – increase across Africa, from Nigeria to Kenya, Egypt to Zimbabwe.
The Q2 Africa Risk Report by Oxford Economics Africa shows that the continent’s median liquidity risk score has deteriorated by just over 10% over the past quarter, indicative of how widespread the issue is.
While salient idiosyncrasies are driving this deterioration, the broader trends include ongoing efforts to fund wide external imbalances; portfolio outflows due to weaker market sentiment; forex losses due to currency market interventions, and an uptick in external debt servicing as pandemic-era repayment holidays come to an end.
Nigeria’s perennial struggles with external liquidity persist and have intensified this year. Forex holdings are still trending lower and recent hiccups in oil output do not bode well for export receipts going forward: oil output plunged nearly 20% in April, with Nigeria once again losing the title of Africa’s largest oil producer.
The main drag on Nigerian forex holdings, however, is the government’s resolve to prop up the naira exchange rate, which has proven to be a foreign exchange furnace.
The newly elected government is likely to uphold the policies of the current administration, which means tiptoeing around difficult decisions on exchange rate policy until the situation becomes untenable. Delays in scrapping fuel subsidies show that the government does not want to rattle a cagey socioeconomic situation.
While businesses operating in Nigeria have grown accustomed to these challenges, they are a lot less familiar to Kenyan firms. The reasons for Kenya’s liquidity quagmire are manifold: wide fiscal and current account deficits, currency support and stricter rules on the interbank foreign exchange market, to name but a few.
While the causes are complex, the symptoms are simple: Kenyan businesses are struggling to secure hard currency.
This is leading to supply chain challenges and stoking price inflation. A year ago, the Kenyan government could at least, to some extent, rely on foreign investors to take advantage of attractive yields. Now, Kenyan yields tell an ominous story.
The spreads on Kenyan Eurobonds have trended above 10 ppts in recent weeks, which is generally considered a threshold for distressed debt.
With private investors taking a very dim view, multilateral organisations have come to Kenya’s rescue.
Disbursements from the IMF, World Bank and Afreximbank are expected within the next few months, which will help reduce liquidity-related risks.
While multilateral institutions are coming to Kenya’s rescue, the same cannot yet be said of Egypt. Import controls and currency restrictions are exacerbating existing challenges to accessing essential inputs, and it looks as if Egypt is heading towards a balance of payments crisis.
It is pretty clear what the government needs to do to ease these pressures – another Egyptian pound devaluation. But the potential fallout even has strongman President Abdel Fattah Al-Sisi worried. Egyptians are struggling with surging prices while the country’s economic growth is weakening.
Unacceptable increases in bread prices often portend the fall of a regime in Egypt, and Egyptian authorities will not want to tempt fate.
However, another devaluation seems to be an externally imposed fait accompli: non-deliverable forward contracts on the Egyptian pound are signalling that another sharp devaluation of over 10% is on the cards.
If this does not form part of the central bank’s plans, it could become a self-fulfilling prophecy as markets increase pressure on the local unit. The IMF’s delay in completing its first review of Egypt’s Extended Fund Facility – delays that are blocking the release of critical external funding – provide further reason to believe that another devaluation could be on the cards.
The IMF would reportedly like to see more progress on reducing the role of the state in the economy, and, importantly, liberalising the exchange rate before the first review is completed.
Liquidity risk has been a hallmark of frontier investing.
The recent increase in liquidity risk is undoubtedly cause for greater scrutiny, but not for despondency. Multilateral organisations are stepping up and the institutional improvements related to many of these programmes could have a lasting impact on operating environments.
In turn, the recent debt deals brokered on behalf of Ghana show that even entities that do not normally play well with each other, like the Chinese government, Bretton Woods institutions and other national lenders, can cooperate if the situation calls for it.
Furthermore, investing is not the same as gambling, and while not being able to cash out would deter a gambler, attempts to make a quick buck is a surefire way to get your fingers burnt as an Africa-focused investor.
The continent’s economic appeal is in the long game, and that has not changed. DM