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Q3'23 FX OUTLOOK: Assessing external reserve adequacy across SSA - Geopolitics keeps the heat on SSA currencies

As supply chains have eased considerably, contributing to lower inflation expectations, there are upside risks to global inflationary pressures from the expiration of the Black Sea deal in July, resulting in Russia’s withdrawal from the Black Sea deal. Amid these risks, most currencies under our coverage have been weakened thus far in Q3. Although inflation has declined below 4%, the US Fed maintained its hawkish stance, raising rates in July after a brief pause. Higher US interest rates had an adverse effect on the appetite for emerging market currencies. The South African Rand has particularly weakened but recovered slightly thereafter amid a weaker dollar and the easing of power cuts.

Reserve Adequacy: South Africa, Nigeria, and Angola lead the pack In assessing the reserve adequacy of emerging and frontier economies, three broad classes of indicators are used – Import-based measure of reserve adequacy, Money-based measure of reserve adequacy, and debt-based measures of reserve adequacy. Beginning with the import cover indicator, all our coverage economies have reserves above the rule of thumb (3 months) except Ghana. After adjusting Nigeria’s reserves for short-term foreign currency drains, import cover fell from about 7.9 months to 5.2 months. Unsurprisingly, Ghana’s import cover falls short of the required levels, following the capital flight of 2022. Moving on to the money-based indicator of reserve adequacy, we assessed the capacity for capital flight from the currency by residents, although we note that this measure becomes useful for assessing reserve adequacy in economies with fixed exchange rate regimes, unstable demand for money, or a weak banking system. Taking a brief look at our dataset, it becomes apparent that Angola is the most equipped to handle a scenario where domestic residents initiate capital flight, while South Africa emerges as the least prepared in this regard.