By Pitamber Kaushik
As the Federal Reserve, the central bank of the United States, continues to hike its lending rates aggressively in order to rein in persistent inflation, the stress exerted by the bulking US Dollar continues to send ripples throughout the world. Being the predominant medium of international exchange, serving as the world’s principal reserve currency, and being the official or de facto primary currency in some 16 countries, the American dollar wields sizable influence on the global economy.
Most African countries are still reeling from the effects of the pandemic and some are going through its aftershocks. High inflation pervades the continent. Sub-Saharan Africa, in particular, is experiencing severe inflationary pressure given its overwhelming reliance on imports for staple foods, among other things. Imports of many items are mapped near-one-to-one, i.e. a country sources a particular item near-exclusively from a particular country. The demand for staple food-items being price-inelastic spells doom for these nations in such a scenario.
The War in Ukraine has triggered an inflation boom that has spelt adversity for Africa. Egypt, Libya, Tunisia, and Benin, among others, have suffered food insecurity because of their heavy reliance on Ukraine for wheat. Many countries which were the sources of other food items for various African nations have suffered from other indirect effects of the war and have consequently fallen short on their supply to the continent. In our unprecedentedly extensively economically connected and interdependent world, a disruptive event as the Ukraine war precipitates far-reaching and often difficult-to-predict ramifications. The pervasive food, energy, and mineral shortages resulting from Russia’s invasion of Ukraine affected the economy and industries of the various countries directly dependent on them for the same. These consequent secondary shortages in turn led to adverse shortfalls in their exports to other countries, leading to raw material shortages and economic downturns which in turn precipitated tertiary shortages, there and so on. Each link in such causal chains exerts lateral strain which is felt hardest by the most dependent and deprived nations.
Such existent inflationary stresses are magnified by the strengthening of the dollar. As the central bank of the world’s biggest economy strives to contain its inflation, it elbows into the rest of the globalist 21st-century shrunk world, stretching various economies collaterally.
As an illustration of the swelling disparity, consider the fact that the exchange rate between the US Dollar and the Egyptian pound has grown to around 24.6 in late November from about 15.7 in early March, a level around which it had roughly hovered since the beginning of 2020. The rift between the US Dollar and Ghanian Cedi has sharply widened as well, as the exchange rate has climbed from 6 to 14.5 over 2022, i.e. in the span of a year.
With the passage of time, the ripples of strain radiating from the dollar’s growing heft would traverse throughout the continent’s economies, prompting a tightening of trade and resulting in more stringent financing norms. Further, government debts would burgeon while debt-servicing would become tougher and tougher.
As the greenback gains heft, it would make the general global economic environment more viscous and countries around the world would find it difficult to swim through this denser financial medium. As economic activity gets impeded, most other currencies would begin to get attenuated, thus further feeding the dollar’s potency. As the dollar is fuelled further, it would further strain economic activity, reinforcing the relative downfall of other currencies, thus establishing a self-intensifying death-spiral, commonly referred to as the ‘dollar doom loop’.
Most nations in Africa find themselves in a seeming Catch-22 situation where indefinitely driving up interest rates to counter currency depreciation pressure exerted by the dollar would be risking an economic downturn, thus constituting a precarious and indefinite tightrope-walk, while alternatively, deploying forex to moderate the currency market would jeopardise their depleted foreign currency reserves (owing to pandemic-time deliberate public-spending and dearer-imports). Any such macroeconomic policy measures would need to be taken meticulously with foresight, constant monitoring, and prompt fine-regulation.
Central banks of many African nations had already been tightening their lending to curb war-driven inflation. As many dollar-denominated imports steeply grow dearer while gains from exports are meagre, it is becoming increasingly tougher for banks to fetter the intensifying inflation. Most trade financing is billed in dollars. Add to this the fact that most banks rely on dollar liquidity as an important criterion for determining conditions for financing trade.
Enterprises in nascent and developing economies lack reserves to self-finance or sustain and rely on working capital sourced from banks. Both the lack of control measures and stringent control measures adversely affect economic growth prospects. With the strengthening dollar, an environment of insecurity and lack of confidence results, discouraging new businesses, compoundingly shrinking economic activity right from government and central bank policymakers to young entrepreneurs. Countries are justifiably wary of accumulating further debt in such precarious times when the existing debt is quite sizable, often denominated in dollars, but given the domestic lack of capital, the other alternative is sacrificing much-needed economic growth, particularly post-pandemic recovery.
The current situation for Africa seems bleak and there’s no panacea. Any solution would incur a tradeoff – it is important to prioritise and appropriately contextualise potential responses to the conundrum. There is no one size fits all solution for Africa and even within a country, any policy implementation would need to be scrupulously calibrated, continuously monitored, and timely regulated.
Gradually raising interest rates while closely monitoring its effects seems to be the best option, particularly for countries that have low forex reserves. Countries facing high demand and critically depleted forex reserves but sustaining appreciably brisk economic activity could even go for a robust interest hike. On the other hand, those facing or risking domestic recession but sustaining decent trade balance should opt for currency market interventions. Moreover, legislative and executive financial reforms, particularly devising a robust monetary policy and streamlining domestic and international trade are essential for all countries. Enacting structural and regulatory reforms and investing in various targeted community-elevation measures aimed at affirming a basic, steadfast socioeconomic support structure, promoting grassroots economic activity at the community-level, and building climate resilience are key to managing the crisis. Encouraging bottom-up community-level entrepreneurship by providing diverse non-monetary stimuli particularly in the agricultural, agro-business, tourism, and research & development sectors would be the best strategic intervention the governments can make in the current scenario. Making sustainable medium-term stimulative investments aimed at gradual collective capacity and resilience building coupled with balanced fiscal and monetary regulation, sophisticated bureaucratic reform, and introduction of accommodative social security measures would enable African nations to chart a course and cautiously navigate through the perilous waters of the current economic crisis, avoiding the whirlpools of debt traps, currency crashes, doom loops, and depression.
Pitamber Kaushik is a writer, journalist, columnist, educator, and independent researcher. His writings have appeared in over 220 publications across 50+ countries. He is currently based out of XLRI (Xavier School of Management), Jamshedpur, India.