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The King Dollar: A cause for concern for Africa’s hard-to-reach markets

Whilst falling short of the heights seen in September 2022, the US dollar continues to reign supreme as the world’s preferred currency for international payments. As its dominance continues to impact cross border payments into and out of the Global South, the real impact on hard-to-reach markets needs to be addressed. On one hand, using the Dollar as a settlement currency has benefits due to its liquidity and stability. Conversely, the sheer dominance of the dollar presents friction for both senders and receivers who may prefer to transact in the local currency. For example, the use of the dollar often results in small businesses in Africa paying up to 200% more than larger businesses to clear transactions.

Additionally, because of this dominance, whenever there's fluctuation toward higher interest rates in the US, this can be quite damaging for markets such in Africa or other Global South Regions, where the dominance of the Dollar means a weakening of the local currencies. Investors in the Global South tend to pour capital into the dollar with these market currencies weakening as a result. This has recently caused increased debt levels in economies such as Ghana and Uganda.

A strengthening dollar, along with commodity prices rising due to geo-political factors, has put these African markets into a pincer. Decades of reliance on the US dollar, which is  a tax on emerging market currencies, has now been brought into focus through this current predicament.

Especially as we enter an unprecedented, intense period of currency volatility, the implications of Dollar dominance in cross border payments for hard-to-reach African economies, which are already suffering disproportionately from geo-political crises, is in danger of being ignored.

Hampering prosperity for hard-to-reach African economies

45% of payments made from Africa are made in Dollars, made using the SWIFT network. This creates significant friction as the USD exists parallel to regional currencies, directly impacting trade and market growth. Intra-African payments alone made in intermediate currencies are estimated to cost the continent $5bn each year, which restricts local prosperity.

Suppliers of key imports to the Global South have historically expected buyers to pay for goods using dollars or other intermediate currencies, due to concerns around currency volatility. However, for those residing within the emerging markets, getting hold of hard currency is not easy. The availability of US dollars in many African countries is scarce, and often doesn’t filter down to SMEs. In addition, businesses can wait for weeks to accumulate funds to pay overseas suppliers or reduce their operations as a result of lack of hard currency liquidity.

The frictions around cross-border payments not only result in high FX fees, they also have a significant impact when it comes to intracontinental trade. The value of intra-Africa trade is notably low in comparison to other regional blocks. Data from the UN reveals that only 17% of total African exports go back into the continent, compared to intra-EU exports of 68% and intra-Asia exports of 60%. This results in more capital leaving Africa than entering it –  another factor which limits the growth of African economies, particularly SMEs. FX inefficiency and dysfunction is a significant barrier for intra-Africa trade, and restricts the prosperity of African supply chains.

The impact of ignoring the worsening situation

While the Dollar remains strong, the global economy is fragile, and the situation is set to worsen throughout 2023. This will inevitably exacerbate the existing dynamics around cross border payments, leaving African economies bearing the brunt of friction points in the existing payments ecosystem.

By continuing to rely on the Dollar for cross-border payments as opposed to facilitating South-South currency flows, the financial situation of African economies will stagnate, with SMEs set to feel the impact most strongly.

Reliance on the Dollar must be reduced. This can be done by creating better global banking links that facilitate Africa-Africa currency pairs and payments, and remove the intermediary of the Dollar. Allowing local businesses and people to fund payments to non-US jurisdictions in local currencies will allow the avoidance of the challenges associated with the scarcity of hard currency.

 

 

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Omar El-Gazzar

Omar El-Gazzar

FX Dealer

Crown Agent's Bank

Member since

22 Mar 2023

Location

London

Blog posts

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