By Irmgard Erasmus
1 JULY 2016-Four days 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?
On June 23, British voters participated in a referendum in which the question was: “Should the United Kingdom remain a member of the European Union or leave the European Union?” The ‘Leave’ campaign secured 51.9% of the vote, in contradiction to poll projections which had suggested a marginal victory for the ‘Remain’ camp. Turnout was 71.8%, meaning more than 30 million Britons cast their vote. The surprise result catapulted global financial markets into turmoil, weighing on risk assets in the wake of the shock to confidence, leaving analysts and traders to recalibrate economic and financial models amid heightened uncertainty about the path ahead.
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.
Short-term impact on Africa
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 the Zambian kwacha, the Angolan kwanza, and the Ghanaian cedi. In turn, the CFA 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 the Zambian kwacha was 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 both Angola and Ghana. 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. Angola has 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 for Ghana, our baseline expectation is for a pick-up of volatility in the cedi during 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 $918m thee-year agreement and syndicated loan inflows aimed at the cocoa sector by October, partially counterweighed by lower sovereign credit inflows.
Risk to the Kenyan shilling come from the shock to global confidence, extensive trade links between Kenya and the UK, and a decline in the domestic real interest rate, but we think tepid trading activity and conservative central bank liquidity management will keep the shilling’s depreciation modest in H2. We anticipate that the shilling will trade at around KSh106.95/$ 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 that Ghana may 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 that Ghana and Zambia, 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.
Longer-term impact
The longer-term impact of Brexit is far harder to forecast, given all the variables that will play a role. The political situation the UK is very fluid. Prime Minister David Cameron announced on Friday, June 24, that he will resign as soon as his Conservative Party picks a successor for him. Nominations for this position open on Wednesday, June 29, and it sounds as though the Conservatives will have a new leader by early September. Three contenders have a strong chance of winning the position: Boris Johnson, the former Mayor of London, Justice Secretary Michael Gove and Home Secretary Theresa May. Mr Johnson was a prominent figure in the Leave campaign but considerations of party unity may lead the Tories to appoint Mr Gove or Mrs May – Mr Johnson burned some bridges when he decided to back the Leave campaign, and is not widely liked in his party. Mrs May was a ‘Remainer’, and may look more palatable.
The identity of the next prime minister and the composition of his or her cabinet are relevant because these are the people who will have to negotiate Britain’s exit from the EU, and the nature of the trade relationship that will follow. Mr Cameron has said that he will not himself trigger ‘Article 50’, the article in the Lisbon Treaty that gives a withdrawing state two years to negotiate its exit, counting from the date that it notifies the European Council of its intention. The early reaction from the EU has been predictably vindictive, and it is probable that the EU will press hard to ensure that, if Brexit happens (which some credible commenters, like the Financial Times’s Gideon Rachman, doubt), the ensuing relationship will look like the present one. To this end it will probably take the bargaining position that the UK can only access the free trade area if it accepts a certain amount of movement of people. Immigration was a main plank of the Leave campaign, so this will be politically delicate to sell to the base of Leave voters. If a more centrist figure like Mrs May is appointed, we think it is more likely that the post-Brexit situation will closely resemble British membership of the EU, but if Mr Johnson or Mr Gove lead the party, we think the relationship will be one in which Britain is more isolated from Europe economically. The EU currently operates as a single trade market that allows for the free movement of capital, goods, services and people between member states, and enforces common policies on trade. Reductions on exchanges in any of those categories will have economic consequences.
Gold has always been a safe haven asset – its price increases in times of global uncertainty. In the four days from Thursday to Monday, the gold price went up 9.1%. If political developments and the Brexit negotiations are of a nature to keep risk perceptions high in the coming months and years, this will be to the advantage of Africa’s gold exporters: South Africa, Ghana, Sudan, Tanzania, Mali, Burkina Faso, and a few others. Given the small contribution of gold to trade revenues, however, this beneficial impact will do little to outweigh problems that result from investor uncertainty.
The new British cabinet might also have to implement an emergency budget in response to the economic turmoil of recent days. Chancellor of the Exchequer George Osborne said on Tuesday, June 27, that he would leave any fiscal changes to the new cabinet, and was ambiguous about the possibility that he would be part of that government. If there is a new budget, which may be necessary, and if it is an austerity budget, which is possible, then aid to African countries can be expected to diminish.
Resentment of immigration played a big role in many Leave voters’ decisions, and the new government will be under pressure to do something about migration. As it will not be able to limit migration from the EU for some time, it may decide to score political points (perhaps in anticipation of being unable to deliver a genuine Brexit) by limiting immigration from the rest of the world. Nigeria and South Africa are the two African countries that would be the most affected by this: 2.5% of migrants in the UK were born in South Africa, and 2.4% in Nigeria, according to the Migration Observatory at Oxford University. These percentages translate to absolute numbers of 209,000 and 200,000 respectively. Anecdotally, judging by comments on social media and by people who speak to reporters, many of these people are now nervous about their future prospects for residency and work opportunities in Britain, and they are probably right to be. Leave campaigner Nigel Farage (the leader of the UK Independence Party, UKIP) said on Friday that the UK would now be looking at “maybe re-engaging with the Commonwealth,” but we doubt that it will work out this way. There was a definitely element of racism in the Leave campaign, which was most obvious in its choice of a poster showing a row of Arab migrants in the final week of the campaign. Since the vote outcome, again on anecdotal evidence, it appears that racists in England have begun to feel empowered by the outcome, and there appear to have been more incidents of racist violence and insults than usual, targeting Poles and people who are visibly Muslim (in many instances, British-born ones) especially.
Direct economic effects flowing from lower demand from the UK and Europe will, we think, tend to be slight. These effects will also be limited to the countries that are most open to the British and European economies. Morocco for instance, experiences a 1.8% increase in exports, and a 2.32% increase in FDI stock, if EU GDP goes up by 1%. So the slowdown in the EU and UK as a consequence of Brexit will have some slight effect on such economies and will be disruptive to firms that export to these countries, and to FDI-driven expansion. But here it is again important to reiterate that the longer-term consequences of Brexit are unknown and impossible to forecast, seeing that we do not even know when the negotiations that will determine the relationship between the Isles and the Continent will begin.
WHY DO WE CARE? The surprise Brexit vote once again underlined the adverse impact of unexpected events on the fragile global economic system, and warned that external headwinds may arise from new sources. 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.
Irmgard Erasmus is Senior Financial Economist at the NKC African economics,
