The decline in commodity prices over the last three years has made life harder for many African businesses, as natural resources make up a large percentage of the business landscape on the continent. However, the drop in commodity prices is not the only challenge companies in Africa are facing. Increasing volatility in the African currency markets is also a cause of grief for transnational businesses in Africa.
Commodity-reliant economies such as Ghana, Zambia, South Africa, Angola and Nigeria have all witnessed strong currency volatility last year, with the Ghanaian Cedi and the Zambian kwacha experiencing over 20% annualized volatility in 2015. As prices for both imports and exports fluctuate, cash flows become uncertain and uncertainty is always bad for business.
A Stronger Dollar
With the next U.S. interest rate hike looming and global economic growth stagnating investors have been moving their money into the U.S. dollar. This has lead to the U.S. dollar strengthening steadily over the course of the last few months. In fact, towards the end of 2015 several African currencies weakened sharply against the U.S. dollar including the Angolan kwanza, the South African rand and the Kenyan shilling, which dropped 20%, 20% and 10%, respectively, according to a report by the German bank Berenberg.
A strong dollar is traditionally bad for emerging markets, including African economies that rely on commodity exports. When the dollar strengthens dollar-denominated commodity prices tend to decrease, which hurts commodity exporters as it leads to a fall in both corporate and private income, which in turns leads to lower economic growth.
South African Rand Weakening
The South African rand has hit an all time low at the start of the year, as fears of an economic slow down in China is taking its toll on African currencies. China’s investments across the continent have helped boost economic growth in Africa, including that of its second largest economy South Africa. Hence, a slow down in growth in China will affect South Africa’s currency, as well as those of several other African countries’, adding further to the volatility of African currencies. This increase in volatility in the rand is not just an issue for those who use South Africa money transfer services, but also for African companies who conduct business across South Africa’s borders.
The way to manage currency volatility as a transnational business is by adopting the right currency hedging strategy. The best way to ensure stable revenue streams, when conducting business across borders, is to hedge currency risk using FX forward contracts. FX forwards are financial derivatives that let you ‘lock in’ an exchange rate for a buy or sell transaction for a specific currency pair at a future date. Commercial foreign exchange companies provide this service to large multinational corporations, but also to local SMEs.
For example, if a South African SME knows it will make roughly KES 25,000,000 from their Kenyan operation in Q1, and wants to ensure it the volatility of the Kenyan shilling against the South African rand does not negatively affect the companies’ revenue, it can enter into a 3 month forward agreement to sell KES and buy ZAR at the end of Q1 at a rate agreed today. That way if the KES weakens against the ZAR, the company’s Q1 revenues will not be negatively affecting by this adverse currency move. The flip side of the use of FX forwards is that they company does not benefit if the currency move is beneficial, as the exchange rate has already been agreed upon for the future date. Since the South African rand is one of the most volatile currencies in the world, however, hedging currency risk for companies who do business in South Africa is imperative.