When the central bank authority of the world’s largest economy shifts its benchmark inter-bank lending rate, it has ripple effects. That extends to African nations, most of which have become increasingly connected with the global markets over the last decade.
What will these look like for the region?
Decreased demand for African bonds
A growing link between the continent and global investors is the exponential increase in African sovereign bond sales. The Fed rate hike raises the possibility of increased borrowing costs for African governments at a time when many are struggling with growing deficits.
Until 2006, South Africa was the only country to have issued a sovereign bond south of the Sahara. That has changed. Sub-Saharan Africa issued US$18 billion in dollar-denominated Eurobonds between 2013 and 2015, more than triple the amount in the preceding three years combined.
Most African government bonds (some with yields exceeding 10 per cent) are serviced in dollars. Much of the appeal to global investors of higher yield emerging markets government debt stemmed from historically low interest rates in recent years on more stable US treasury bonds.
The Fed’s decision to raise baseline rates in the US will likely lessen the draw. “There will probably be an impact on Africa bonds and bond yields because of the fact that investors can now get a better return on US bonds, which are obviously much safer,” says Ben Payton, head of Africa research at business consulting firm Verisk Maplecroft.
A market shift away from African sovereign bonds would decrease their demand driving up the interest, or yield, governments have to pay to appeal to investors.
Payton notes the increase in bond yields will be “bad news in a few cases…for a group of countries (Mozambique, Angola, Gabon, Zambia) where governments are already struggling to service existing debt”.
JP Morgan has warned of a Mozambique default on its 2017 Eurobond commitments. Zambia is reportedly considering a new 2017 Eurobond issuance.
Rising government bond yields, influenced by the Fed rate hike, may also decrease the ability of African governments to raise money through new sovereign issuances in 2017.
So far that this has not materialised. “The impact of Fed tightening, both the expectation of it and the actual move in December, on sub-Saharan Africa’s bond markets has been limited so far,“ says Jan Friedrich, Fitch Ratings head of Middle East and Africa’s Sovereign Ratings.
“There was a pronounced spike of yields in the wake of the US election result, but otherwise yields have remained relatively stable for most Eurobond issuers in the region.”
However, this will be a trend to watch over coming months and the compounded impact of multiple US rate rises.
Equities flight in weak performers
In addition to government bonds, global investors have also fuelled growth in African stocks over recent years.
Sub-Saharan Africa’s stock market capitalisation – excluding South Africa – was less than US$100 billion in 2011. By 2015 it reached US$1.1 trillion, according to data from Nile Funds.
Payton at Verisk Maplecroft sees Africa’s stock markets as less directly influenced by the actual Fed hike. Rather, higher rates and stronger currency in the US could combine with poor performance in some African economies to make those investments look less appealing.
“Where economies are doing well, investors are likely to stay regardless of the Fed increasing rates, whereas as where economies are doing poorly, such as South Africa, investors are going to look at any excuse to put their money elsewhere,” he says.
South Africa is a case in point, where despite a relatively advanced economy and highly capitalised stock market its currency looks to be badly affected by Fed-fuelled US dollar appreciation.
This dynamic “creates a negative bias for emerging market currencies,” says Samir Gadio, Standard Chartered’s head of Africa strategy. “For African currencies specifically, however, we have to nuance for those that trade and have flexible exchange rate platforms.”
The South African rand― Africa’s most traded currency ― has already been most impacted by a shift in the value of the dollar since the Fed rate hike according to Mr Gadio, accelerating a long-term downward trend. The Kenyan and Ugandan schillings follow in facing the sharpest losses in value on a rising dollar.
Question marks on trade
Foreign exchange, by extension, heavily influences trade. The total value of Africa’s trade with the world topped $1.1tn in 2014, according to the UN Conference on Trade and Development (UNCTAD).
China (US$220 billion) and the US (US$52 billion) are the continent’s leading partners.
The Fed hike, and expected 2017 increases, will likely have inflationary effects in some of the larger economies in Africa such as South Africa and Nigeria. Both currencies are already struggling due to weak economic performance, making imports more expensive and diminishing consumer buying power.
For miners and the economies that depend on them, the outlook is also challenging. A stronger dollar could tempt investors to shift away from gold – a haven asset – reducing demand from miners in the likes of South Africa and Zambia, Mr Payton posits.
A similar effect could also extend to petroleum producing countries, such as Nigeria and Angola. “To the extent a Fed rate hike influenced investors in oil contracts to shift to dollar-denominated assets, this could lead to further downward price pressures on oil, adding to the commodities price shocks petroleum producing countries,” says Moody’s analyst Rita Babihuga.
Bigger headaches: Trump and China
Other events in the US have the potential to overshadow any movements the Fed might make, however.
Uncertainty around what will happen in the US economy under a Trump administration is perhaps the biggest question mark. If the big tax cuts, massive spending on infrastructure, and more borrowing that markets are currently betting on actually materialise, stronger US rates and a stronger dollar will follow.
This could bring “emerging markets foreign exchange and African external bonds under more pressure,” says Gadio of Standard Chartered, magnifying trends already seen in the immediate wake of his November election triumph.
Longer-term, an American boom could increase prices for African commodity exports and oil. Many exporters’ economies have been devastated by the last few years of low prices. A decision to cancel America’s newly minted pact with Iran, for instance, could boost the price of oil in Nigeria, for instance.
US-China relations, currently entering unstable and uncharted waters, could have roundabout impact on Africa via its close economic linkages with the Asian economic powerhouse. “The general performance of the Chinese economy is crucial for Africa,” Payton points out.
“If the incoming administration brings a worsening relationship that results in negative economic consequences for China, that will have knock on effects on many countries in Africa that depend on Chinese demand.”
Africa’s economists will be scrutinising moves by both the US Federal Reserve and White House in the coming year, perhaps with greater intensity than usual.