A week after the announcement of the result of Britain’s referendum on leaving the European Union (EU), what can we say about Brexit’s impact on Africa?
Strictly speaking ‘Brexit’ refers to Britain actually leaving the EU, which will not happen for some years at least, but in what follows the word is used to refer to the referendum result and the uncertainty it has provoked.
The immediate impact on Africa was largely contained to the continent’s most sophisticated market, South Africa, weighing on both the fragile rand and the Johannesburg Stock Exchange (JSE). Due to the depth of liquidity and range of financial market instruments, South Africa is viewed as a liquid risk proxy for the sub-Saharan African (SSA) region.
By contrast, external spillover effects to the rest of the continent were considerably more muted and largely contained to the more liquid sovereign credit and currency forward agreements.
Still, volatile global risk sentiment and systemic risk concerns brought forth anxieties with regard to the potential impact on Africa in the wake of the unprecedented Brexit vote.
In our view, the direct impact of Brexit on Africa will be contained to the forex and financial markets over the short term.This will primarily filter through to the real economy via the indirect impact of global risk sentiment on commodity prices, impacting the balance of payments and the monetary system, and implying that the upside risks to inflation have increased on account of exchange rate pass-through.
This pertains in particular to the case of South Africa, where we were already expecting continued monetary policy tightening.
Thin liquidity conditions and idiosyncratic risks limited the immediate impact of global market malaise on African financial assets, although we anticipate increased volatility in the spot and forward rates of commodity price-sensitive local units.
We view the currencies most at risk from external headwinds as theZambian kwacha, theAngolan kwanza, and theGhanaian cedi.
In turn, theCFA franc zone, under the two common monetary unions (the Central African Economic and Monetary Community, CEMAC, and the West African Economic and Monetary Union, WAEMU) is implicitly vulnerable to EU developments via the impact on the euro exchange rate. CEMAC and WAEMU peg their currencies to the euro at the same rate.
In recent sessions, the impact on theZambian kwachawas mitigated by cyclical factors as tax obligations brought about an increase in forex supply. In addition, the price of the red metal found reprieve as markets started to expect that US monetary policy will turn more dovish; this has weighed on the dollar index, and this has aided copper futures in recent sessions. Nonetheless, in our view the kwacha remains vulnerable to spillover effects from Brexit via the copper price, considering the red metal’s position as barometer of global risk sentiment due to its prevalence in industrial processes.
Heightened global risk aversion, via the risk-sensitive copper price, will weigh on the kwacha (in our view on forward rates more than the spot rate) during the latter half of the year.
The oil price fell by 8.3% from polling day until Monday, June 27. Depending on political developments, market uncertainty may continue weigh on the oil price, and as a result we estimate that forex tail risks have increased in bothAngolaandGhana. Both countries struggle with structural twin deficits, which introduce a structural bearish bias to the local currency units, exacerbated by cyclical stressors and eroding foreign buffers.
Angolahas already allowed for substantial pass-through of balance of payments pressure to the monetary environment via a successive of large devaluations in recent months. While the oil exporter has requested financial and technical support from the International Monetary Fund (IMF), we anticipate that further devaluations may be on the cards should global demand for crude oil fall substantially below market expectations.
As forGhana, our baseline expectation is for a pick-up of volatility in thecediduring the latter half of the year on account of rising exogenous problems and the apex bank’s reduced ability to intervene on the forex market. That said, we estimate that forwards priced in a too-large depreciation, and project that by the end of the year the local unit will be trading just below GH¢4.1/$.
This is in consideration of another tranche of IMF funds under the $918m thee-year agreement and syndicated loan inflows aimed at the cocoa sector by October, partially counterweighed by lower sovereign credit inflows.
Risk to theKenyan shillingcome from the shock to global confidence, extensive trade links between Kenya and the UK, and a decline in the domestic real interest rate, but we think tepid trading activity and conservative central bank liquidity management will keep the shilling’s depreciation modest in H2.
We anticipate that the shilling will trade at around KSh106.95/$ by year-end. The renegotiation of trade deals may however add to structural depreciatory pressure on the shilling, and a lower UK growth trajectory may oscillate on Kenyan soil due to reduced demand for Kenyan export products.
In addition to the impact of confidence erosion on commodity prices, we anticipate that de facto tightening of financial conditions may impede the attainment of sovereign credit targets of fiscally-fragile African countries.
In light of international risk aversion, structural imbalances and the lack of fiscal space to commit to new projects, we think thatGhanamay struggle to drum up sufficient appetite for a new sovereign credit offering this year.
On the other hand, performance of outstanding sovereign credit is seen under pressure in 2016 H2 should Brexit concerns weigh on commodity prices throughout this period.
Included in our base view is a revision of assumption with regard to the resumption of US interest rate normalisation. Whereas we pre-Brexit anticipated a July rate increase in the US, we now think that the Federal Open Market Committee (FOMC) will – in consideration of global financial market turmoil – stand pat on tightening until December.
While negative market sentiment internationally will resonate across commodity price-sensitive African sovereign credit (including in Gabon, Senegal and Nigeria) we think thatGhanaandZambia, which both hold elections during the latter half of the year, are most at risk of yield jumps and heightened volatility in the medium term.
Idiosyncratic risks relating to off-balance sheet debt will keep Mozambique’s sovereign credit performance largely dependent on developments on the debt and foreign aid front.
In our view the short term impact of Brexit will largely be contained to liquid forex (forward and spot) markets and sovereign credit, although this will increase upside risks to inflation due to the first and second-round effects of exchange rate pass-through.
Economies may need more aggressive monetary policy tightening to rein in growth in consumer prices and to anchor inflation expectations.
For fiscally-fragile economies, balance of payments pressures will quicken the pace of foreign buffer erosion, and may necessitate further reduction in growth-positive infrastructural investment.
We consider a deepening of the commodity price slump as unlikely, although this outcome would inevitably increase pressure on the fiscus and terms of trade insofar politically-sensitive recurrent costs would need to be cut.
Tight external financial conditions and constrained domestic liquidity conditions in SSA will act as an additional drag on growth this year. In the longer term, it is too soon to say what Brexit’s impact will be.
While Brexit has added to volatile global risk sentiment, we continue to view systemic risk from China as the singular most salient source of external risk to Africa’s economies.A sharper-than-anticipated pace of economic slowdown, or sectoral rebalancing, in the Asian economic giant will have effects on African soil via large direct (bilateral trade) and even larger indirect channels, due to the shock to the regional terms of trade in light of depleted foreign buffers and inadequate policy reform.