1. Emerging Challenges
Monday 23 August 2015, was a terrible day for global markets as sell-offs hit global stocks across almost every sector driven by China’s stock market. As at close of day, what had generated the Twitter hashtag #BlackMonday, had left in its wake the following (summarized version of media reports):
- The Shanghai Composite tumbled by 8.5 percent, its biggest fall since 2007. That plunge wiped out all of this year’s gains. Stock markets in New York, London, Paris and Frankfurt fell sharply as fears of a Chinese economic slowdown continue to haunt investors. London’s FTSE 100 index closed down 4.6 percent with major markets in France and Germany down by 5.5 percent and 4.96 percent respectively. In total, £73.75bn was wiped off the London’s FTSE on Monday according to the BBC.
- Consequentially, commodities and many emerging markets currencies have suffered sharp drops as many are dependent on booming trade and strong Chinese demand. Oil prices have plunged to six-year lows, amid concerns about waning demand for commodities from China. Oil price traded at $42.51 on Monday, the lowest level since March 2009. South Africa’s rand hit its lowest level in 19 months. In Zambia, a major copper producer for China, the kwacha has fallen to an all-time low of 8.5750 versus the US dollar according to Quartz.
2. China Plunge: Why the blip?
- Well, amidst concerns that a slowdown China was worse than originally feared, the central bank devalued the yuan by almost 2 percent on 11 August 2015 in a bid to raise competitiveness by making Chinese exports cheaper. It is reported that Chinese policy makers are prepared to let the currency devalue by as much as 10 percent. Exports fell by 8.3 percent in July and the producer price index was down 5.4 percent from a year earlier, reports the BBC.
- Investors, in the absence of reassurance from the Chinese government, have been reluctant to buy or hold on to Chinese equities.
3. Implications for frontier African markets
3.1 Weak Commodities Demand
- The impact of the recent slump in Chinese growth prospects is not only limited to European, American, South East Asian and Pacific markets. A prolonged fall in demand from the world’s second biggest economy has fundamental implications for many African countries, particularly primary commodities exporting and resource dependent ones. “Sub-Saharan African exports to China increased from 0.1 percent of regional GDP in 2000 to 0.5 percent of GDP in 2012, and this demand has been a key driver of SSA’s strong economic performance over the past decade or so”, argues the FT.
- A China-led global slowdown will hurt primary commodities export countries such as South Africa, Zambia, Sierra Leone, Liberia, Ghana, Nigeria, Angola and DR Congo, which have seen their economies boom because of increased demand from China over the last decade. For many African emerging market economies that are heavily dependent on China, a persistence of the recent rout could have negative implications for their domestic economies. Budgets will have to be rebalanced via spending cuts and/or a depletion of forex reserves in the short-term as oil and mining revenues plummet. Many currencies of African economies may further depreciate against the major world currencies as forex supplies dwindle.
- Trade between China and Africa totalled $220 billion last year, three times the trade between United States and Africa and up from about $10 billion in the early 2000s― the majority of this being raw materials like copper, iron ore, crude oil and some finished products like wine and apparel. As the IMF notes in a policy paper, “although rising trading links with China have allowed African countries to diversify their export base across countries, away from advanced economies, they have also led SSA countries to become more susceptible to spillovers from China. Based on panel data analysis, a 1 percentage point increase (decline) in China’s domestic investment growth is associated with an average 0.6 percentage point increase (decline) in SSA countries’ export growth. This impact is larger for resource-rich countries, especially oil exporters.”
3.2 Contagion Effect Combined with a Potential US Fed Interest Rate Hike
- Many of the frontier emerging markets in Africa namely Nigeria, South Africa, Cote D’Ivoire, Kenya, etc., are deeply integrated into the global financial system through the nexus of portfolio investment inflows into government securities and local equities as well as foreign direct investments (FDI). A lot of African currencies such as the Ghanaian cedi have come under speculative attacks in recent months from market traders due to weak economic fundamentals based on declining export revenues, slow growth and persistent budget and current account deficits.
- The announcement by Ghana’s central bank to allow offshore investors to buy only medium- and long-term government securities of maturities of three years and above will improve short term forex management, but this has the downside risk of further exposing the country to market volatility as investors re-adjust their portfolios should the US Fed move to hike up interest rates in September as is being speculated. Ghana witnessed a bout of this with the cedi’s depreciation in 2014 following withdrawals of portfolio investments after tapering efforts of the US Fed left it vulnerable to curtailments in international capital flows. For example, as at December 2014, 56 percent of Ghana’s debt stock was external debt ― 39.3 percent of 2014 GDP, up from 26.2 percent of GDP recorded in 2013.
- The challenge of high domestic interest rates has encouraged many governments and companies to seek external financing often in the form of short-to-medium term debts. However, servicing becomes an issue when domestic currencies depreciate making debt sustainability a pressing challenge.
3.3 Chinese Funded Projects
- Weakened demand from Chinese makes it more likely that the Chinese government will halt its expansionist drive in frontier African countries at least in the short to medium term. The Chinese government in a bid to bolster its reserves will increasingly become more unlikely to fund new mega projects such as railways, roads, dams, housing in many African countries.
- Private sector Chinese investments into mining and manufacturing industries such as textiles, glass, shoe and car production facilities as well as sugar refineries and steel factories may be delayed.
- China’s slowdown poses fundamental risks to Africa’s growth prospects. Sub-Saharan Africa’s growth prospects will slow to 4 percent of GDP 2015 amid falling commodity prices buoyed by weakening terms of trade for the region’s commodity exporters and gains for importers as the World Bank notes in its April 2015 Africa Pulse report. The report further states that “deterioration of trade terms is estimated at 18.3 percent for the region, with declines of about 40 percent for oil-exporting countries… lower commodity prices will weigh heavily on exporters, putting pressure on current account and fiscal balances. Countries that stand to lose the most are the less diversified oil exporters, such as Angola and the Republic of Congo… By contrast, net oil importers, such as Kenya and Senegal, are set to see modest gains from cheaper energy prices.
- Finally, on the external front, the report states that “a sharper-than-expected slowdown in China, a further decline in oil prices, and a sudden deterioration in global liquidity conditions are the main risks.” Hence, the slump in China, if persistent, could pose fundamental economic challenges for policymakers in many African economies, particularly primary resource dependent ones by way of reduced export demand and curtailment of foreign direct investment in infrastructure, manufacturing and mining. As has been said “if China sneezes, Africa can now catch a cold”