RMB: How the pandemic has impacted valuation of African currencies

The Rand Merchant Bank has released its Milk Index, showing how the COVID-19 pandemic has affected the valuation of African currencies. According to the index, some currencies have been left significantly overvalued, while others have managed to stay near fair value. Neville Mandimika, RMB Africa Economist and Strategist, discussed the findings on CNBC Africa. Mandimika pointed out that the Kenyan Shilling is relatively fairly valued, showing only a marginal overvaluation of about 2%. This is a significant improvement from the onset of the pandemic when many currencies were extremely overvalued. On the other hand, the Rand has moved into overvaluation territory due to its strength over the past year. Currencies like the Nigerian Naira and the Egyptian Pound also show a slight overvaluation. Mandimika highlighted the importance of these insights for corporate viewers looking to manage FX exposure and assess risk. Despite some currencies strengthening, there are still laggards on the continent. The Nigerian Naira, for example, resisted devaluation during low oil prices but is now looking to devalue slightly as stability returns. Each country's currency is affected by unique dynamics, leading to varied movements across the continent. Mandimika emphasized that while African currencies are not free-floating, understanding their valuation from a fair value perspective provides insights into potential risks. As for when the overvaluation of some African currencies might end, Mandimika noted that it doesn't guarantee immediate depreciation. Central banks can use various tools, like FX reserves, to mitigate the impact of weakening currencies on the economy. However, currencies like the Angolan Kwanza and Nigerian Naira are a cause for concern due to disparities between parallel and spot market rates. On the other hand, the Zambian Kwacha is strengthening following recent elections. External factors like the possibility of a September taper by the US Federal Reserve could further impact African currencies. A stronger dollar resulting from a taper could lead to weaker local currencies, bringing them closer to fair value. Mandimika warned that an early taper could accelerate currency movements and increase volatility. Additionally, the Delta variant poses a significant risk, potentially causing global and African lockdowns that may drive investors towards safe-haven assets like the dollar, further affecting local currencies. These risks are crucial considerations for the remainder of 2021 and as we head into 2022.