China’s recent devaluation of the Yuan has raised questions within the global economic community. Quantum Global Investment Management analyse the potential reasons for this, as well as the future effects of such a move for Africa.
China is the largest single emerging economy in the world. Its firms have contributed to an environment based on innovation and consumption. This is expensive and difficult to sustain on a domestic level. Therefore, the Chinese have found an ideal partner in the African continent.
Over the years, Chinese reserves have been recycled into large loans for infrastructure across various countries. Meanwhile Asian demand for African commodities has been driven by rapid economic expansion in China. This dynamic has been broadly beneficial for both parties for more than a decade. Trade in 2014 between the two was almost $220bn; three times that of trade between China and the US.
Simultaneously, Africa’s growth has been in a boom since the early 2000s. In 2014, the continent’s GDP grew 5.1%, with the Sub-Saharan composition growing approximately 6%. Investors and capital flows were drawn to the African “frontier” space, as markets began to stabilise after the 2008 financial crises. Yields remain more compelling compared to other Emerging Market economies. Africa is a long-term play, with private equity and infrastructure projects leading the way. Foreign Direct Investment numbers for 2014 indicate an increase of 65%, reaching over $85bn USD. Over two thirds of this was allocated to Sub-Saharan deals and a large proportion with an energy commodities focus (oil and gas), as well as real estate and infrastructure.
Recently, China’s growth has slowed from a double-digit average in 2010, to an official 7%. Chinese policymakers have been pressured into dropping the currency peg against the US Dollar, devaluing the currency by an initial ~3%. This was unexpected by investors as they saw the largest single-day drop in the Yuan, since 1994 which sent markets into a turbulent “risk-off” mode. Many are now assessing what the devaluation and its timing mean for the likelihood and extent of a Chinese economic slowdown.
Given the lack of availability of the Yuan internationally, the vast proportion of trade and infrastructure deals are financed in USD. As the dollar has been appreciating against African currencies, the impact of the Chinese currency could be dampened for Africa and more important to the U.S. The main concern to policymakers in Africa should be how to manage a slowdown on their own economies as a contagion effect caused by the slowing of China.
In the short-term, it is difficult to see how the devaluation will impact African countries, however on a more long-term basis, we understand the following to be true;
Chinese exports should now be cheaper which will stimulate African consumption. Short-term, this will hurt domestic African manufacturing. Countries in Eastern Africa, such as Kenya and Ethiopia should see a benefit as they are great importers of Chinese-made heavy machinery, for example. African exports, such as wine, gold, oil and copper will suffer.
Unfortunately for many African nations, a slowdown in Chinese growth leaves their commodity driven export economies very exposed. Moreover it is expected that the recent rout across the commodities space will worsen before any price recovery, as part of a long term commodity “supercycle” As Chinese growth has decelerated, so has demand for gold, copper, platinum and iron ore, for which prices have trended to the downside. Crude oil, which is one of the main exports and over 90% contribution to some major countries balance sheets, has also felt the strong effects of a slowing demand from China. With a cheaper Yuan, over the medium-term, growth should tick-up in China once again and Africa’s commodity revenue will increase with a recovery in prices.
In Yuan terms, foreign investment has benefitted. Companies should see the immediate gain in profits, through cross currency manipulation. This will help expansion and in turn, attract further investment into the African economies.
Africa has mirrored china in a dynamic for rapid urbanisation. This has been partly facilitated by homes and utilities, in a trade-off which has allowed China access to Africa’s natural resources and growing markets. Such dependence on China though, makes Africa vulnerable. For example; currencies across the continent have depreciated, amid worries that Africa’s largest counterpart will curtail investment. Chinese buying power would weaken, should the view that growth is less than the official 7% become a reality.
Best indications suggest that Africa should emerge more robust from the temporary pain felt from the recent monetary changes, introduced by the continent’s largest trading partner. Growth throughout the region remains steady and there is evidence of better economic policymaking. Average inflation across Africa is down from 60% in the mid-1990s to less than 10% today. External debt has fallen from 80% of GDP to less than half over the same period. Recent peaceful transfers of power in Ghana, Nigeria and Kenya have also been encouraging. This is attractive to intra-regional affiliates. African countries will benefit from growing alternative lines for trade; with the likes of India and increasing volumes, through partnering more with the U.S. and Russia. Europe is a contender for additional flows as growth gains traction within the region. Elections over the coming year in many African countries also invite accelerated policy reforms, which will be required to adjust to the myriad implications in the medium and long term of significantly slower Chinese growth.
This analysis was prepared by Quantum Global Investment Management.