Financial Security (FinSec) Series with  Philip Takyi (PhD): The paradox of currency depreciation and its impact on African fiscal budgets

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Currency depreciation presents a complex paradox for many African nations—one that reflects both opportunity and vulnerability in equal measure.

On the surface, a weaker domestic currency can serve as a tool to boost export competitiveness by making locally produced goods cheaper in international markets.

However, for most African economies that are structurally import-dependent and heavily indebted in foreign currencies, the negative consequences of depreciation far outweigh the benefits. Currency weakness significantly increases the local currency cost of repaying foreign-denominated loans, thereby exacerbating sovereign debt burdens and inflating fiscal deficits.

At the same time, public sector development projects—particularly those reliant on imported materials, international contractors, and technologies priced in U.S. dollars—become more expensive to execute, often stalling implementation or leading to project downsizing.

This situation is further complicated by the limited fiscal space and monetary flexibility that many African governments face. As currency values erode, inflationary pressures rise, reducing the purchasing power of citizens and pushing governments to revise ambitious budgetary promises that were initially made based on stronger exchange rate assumptions.

Furthermore, the private sector, often regarded as the engine of economic growth, bears the brunt of soaring operational costs driven by expensive imports, supply chain disruptions, and rising interest rates, all of which hinder productivity and investment.

In this article, we delve into the multifaceted impact of currency depreciation on African fiscal budgets. We examine how exchange rate volatility undermines economic planning, distorts the feasibility of infrastructure development, and creates ripple effects throughout the private sector.

Currency Depreciation and Sovereign Debt:
African countries that rely heavily on foreign-denominated debt face significant challenges when their local currencies depreciate. This is because the repayment of debts tied to foreign currencies, such as the U.S. dollar or euro, becomes more expensive in local currency terms.

When a currency depreciates, the amount required to service these foreign loans increases, putting additional pressure on national budgets. Nigeria’s experience in 2024 for example, with the sharp depreciation of the naira, had serious implications for the country’s fiscal health, as the government had to allocate more of its limited resources to debt servicing amidst declining revenues. This highlights how exchange rate volatility can amplify the fiscal vulnerabilities of African countries, particularly those with large foreign debt burdens.

 Infrastructure Development Hampered by Currency Weakness:
A large portion of infrastructure development in Africa depends on the importation of materials and expertise from abroad.

The use of foreign currencies in these transactions makes infrastructure projects particularly vulnerable to currency fluctuations. When the local currency weakens, the cost of importing materials such as cement, steel, and machinery, as well as the cost of hiring foreign expertise, becomes more expensive. This can lead to project delays, budget overruns, and even halting of key national infrastructure projects, affecting long-term growth prospects.

In Kenya, the depreciation of the Kenyan shilling resulted in a significant increase in the cost of imported construction materials, ultimately delaying a major highway project. The same issue affects a variety of projects across the continent, from power plants to transport infrastructure, making currency volatility a serious hindrance to Africa’s economic progress and development.

 Impact on the Private Sector:
The private sector is significantly affected by currency depreciation, especially businesses that rely on imported raw materials, goods, or services. When the cost of imports rises due to currency depreciation, businesses often face reduced profit margins, increased operational costs, and the potential for downsizing or closure.

In Zimbabwe, the depreciation of the Zimbabwean dollar, combined with rampant inflation, led to major companies like Tongaat Hulett announcing mass layoffs. This is a reflection of the broader challenges businesses face in volatile currency environments.

Similarly, MTN Group, which operates in multiple African countries, reported a substantial decline in earnings due to the depreciation of the Nigerian naira and operational challenges in Sudan. These instances underscore the vulnerability of businesses that depend on imports and are exposed to exchange rate risk. In the worst cases, currency depreciation can lead to the exit of foreign investors, further reducing job opportunities and economic activity.

Practical Recommendations

To address the challenges posed by currency depreciation, African nations can consider the following strategies:

Enhancing Local Currency Financing: Many African countries rely on external debt markets for funding development projects, often borrowing in U.S. dollars or euros. However, when their currencies weaken, the burden of repaying these debts increases substantially. Developing strong local capital markets—such as domestic bond markets and equity markets—can enable governments and private sector actors to raise funds in their own currencies.

This approach reduces exposure to exchange rate risk and enhances financial sovereignty. For example, South Africa has a relatively advanced local bond market, allowing it to finance much of its public debt domestically. Promoting domestic savings, improving regulatory frameworks, and building investor confidence are key to nurturing such markets.

Implementing Fiscal Consolidation: Currency depreciation is often symptomatic of underlying fiscal imbalances. Large budget deficits and excessive public debt can erode investor confidence, leading to capital flight and weakening of the local currency.

Fiscal consolidation involves policies aimed at reducing these deficits, including increasing revenue collection (e.g., tax reforms) and streamlining public expenditures (e.g., reducing wasteful subsidies or non-essential spending).

Transparent public financial management and improved accountability can also help restore confidence and reduce inflationary pressures, which are often closely tied to currency weakness.

Diversifying Economies: Many African economies are heavily reliant on a narrow range of exports—typically raw commodities like oil, gold, or cocoa—which makes them vulnerable to global price fluctuations. When commodity prices fall, export revenues decline, leading to currency depreciation and macroeconomic instability.

Diversification involves investing in other sectors such as manufacturing, agriculture, digital services, and tourism. For instance, Rwanda has made deliberate efforts to diversify its economy into ICT and services, which has enhanced its resilience. A more diversified economy not only buffers against external shocks but also broadens the tax base and employment opportunities.

Strengthening Monetary Policy Frameworks: A strong, independent central bank plays a crucial role in managing inflation and maintaining currency stability. Central banks that operate transparently and with clear mandates for inflation targeting can foster investor trust and temper speculative attacks on local currencies.

In addition, building adequate foreign exchange reserves and deploying interest rate policies effectively can help buffer against sudden currency fluctuations. Countries like Ghana and Kenya have adopted inflation-targeting regimes with varying degrees of success, signaling the importance of credible and consistent monetary policy in maintaining macroeconomic stability.

Promoting Regional Integration: Greater trade and financial integration within Africa can reduce overreliance on external markets and currencies like the U.S. dollar. Initiatives such as the African Continental Free Trade Area (AfCFTA) aim to boost intra-African trade, which can help stabilize demand for local currencies and create more balanced trade relationships.

Furthermore, developing cross-border payment systems—such as the Pan-African Payment and Settlement System (PAPSS)—can reduce transaction costs and the need for foreign currencies in regional trade. By trading more in local currencies and enhancing regional value chains, countries can insulate themselves from the volatility of global markets.

Conclusion

Currency depreciation remains a persistent and multifaceted challenge for many African economies, exerting pressure on fiscal budgets through rising debt servicing costs, disrupting critical infrastructure projects by inflating import-related expenses, and undermining private sector competitiveness due to increased operational costs. These effects can stall development progress and deepen economic vulnerabilities if left unaddressed.

However, African nations are not without recourse. By adopting a holistic and forward-looking policy approach—one that emphasizes the development of deep and resilient local financial markets, enforces prudent and transparent fiscal discipline, ensures credible and independent monetary governance, and strategically diversifies economic activities—they can build greater macroeconomic stability and resilience. Furthermore, fostering regional integration and intra-African trade can reduce external dependencies and reinforce collective economic strength.

Together, these strategies not only mitigate the adverse impacts of currency depreciation but also lay the foundation for inclusive, sustainable, and self-reliant economic growth across the continent.

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