The implications of the end of US QE for Africa

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This article first appeared in The East African on January 25, 2015

The US economy is in recovery, having recorded an annualised GDP growth rate of 4.6 per cent in Q2 and 3.5 per cent in Q3 of 2014.

In addition, the period of quantitative easing (QE), which flooded the global markets with dollars, has come to an end. This effectively withdraws $85 billion of net stimulus each month.

Further, the Federal Reserve looks set to increase interest rates in 2015 after a prolonged period of near zero interest rates. In addition to this, the dollar is strengthening. What does this all mean for Africa?

One effect may be that the aggressiveness with which investments in Africa were sought will wane noticeably. Due to the near zero interest rates in the US and other developed markets as well as the US Fed’s QE, excess liquidity had to look for points of absorption.

As a result, investors were more willing to look farther afield for investments, thereby providing speculative capital flows to countries in emerging markets in particular. In fact, this phenomenon may be a factor behind Kenya’s Eurobond oversubscription.

With the end of QE, global dollar liquidity will lessen and this will mean money flowing into Africa and other emerging markets will taper off.

(source: http://nccadp.org/wp-content/uploads/2013/07/photo_6764_20080814.jpg)

Couple this with the expectation of a rise in US interest rates and you have a phenomenon where dollars will run back to the US making them much harder to attract for countries in Africa.

Indeed, now that the US is recovering and the expectation is that an interest rate hike will soon happen, the value of assets in which speculative investments were made in emerging markets may decline in value.

Why? The IMF states that US policy led to a “global search for yield with investors flocking into emerging markets contributing to a broader mispricing of domestic assets.” Now with the end of QE in sight and a recovering US, the value of the assets in which dollars were invested will lower in value. In short there may be deflationary pressure on many asset classes in developing country markets.

Further, far fewer speculative investments may occur because of rising global risk aversion, thereby restricting cheap dollar access for African economies.

The IMF makes the point that the mere announcement of an end to QE led to “rapid currency depreciations, increases in external financing premiums, declines in equity prices, and reversal in capital flows” in some emerging markets.

Another point to consider is made by DK Matai of Quantum Innovation Labs who states that there is a near $8+ trillion in US dollar carry trade.

Carry trade refers to strategy in which an investor borrows money at a low interest rate in order to invest in an asset that is likely to provide a higher return.

(source: http://gbcenter.net/wp-content/uploads/2013/02/shutterstock_127492433.jpg)

Matai makes the point that, “Of that $8+ trillion, $5.7 trillion is emerging market dollar debt… split between $3.1 trillion in bank loans and $2.6 trillion in corporate bonds.”

So there is a global dynamic going on in which “$8 trillion in borrowed US dollars is now being reversed-back into US dollars to repay debts around the world and thereby reduce the dollar-denominated interest payments.”

In short, those who made investments in continents like Africa at low US interest rates will be racing to pay back that debt before the anticipated interest rate hike is made by the US Fed. Given the scale of debt given to emerging markets, this repayment of debt will make dollars less available, strengthening the dollar and reducing liquidity even further.

So, Africa needs to brace for tougher times in the short to medium term as an end of QE and an anticipated hike in US interest rates means “risky” African investments will not be as attractive as they used to be.

Complicating this melange of factors are tumbling oil prices. Low oil prices are associated with a strong US dollar. The current account and government expenditure of African countries for which oil exports compose a significant portion of revenue will be negatively affected.

Further, due to the strong dollar, African currencies will be losing ground, particularly those of countries such as those in East Africa whose currencies are actually weakening anyway as well.

Thus, although African import economies will benefit from low oil prices, which should have a positive effect on current account deficits, a strengthening dollar and weakening local currency will mean that imports are more expensive, thereby countering the lowering of inflation that low oil prices may have encouraged.

Therefore Africa, at least in the medium term, may increasingly turn to China to sustain capital flows strengthening the Look East creed of many African governments.

(source: http://economictimes.indiatimes.com/photo/39666293.cms)

On the other hand, on Thursday the European Central Bank announced a QE programme that will pump out up to Euro 60 billion a month. There is a chance that Africa can benefit from this, especially in light of the end of QE by the USA.

Let’s see how African governments and markets respond to what is an interesting blend of dynamics.

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