How sub-Saharan Africa can scale trade finance amid hard currency challenges

By Onome Amuge

Sub-Saharan economies have for a long time been plagued by foreign exchange shortages, especially against the US dollar,fanning inflationary pressures across the continent as import prices continue to surge.

This has left many policymakers across the continent with difficult choices on how to overcome foreign currency liquidity challenges, promote trade finance, and foster sustainable economic growth in the region.

According to industry experts, currencies play a major impact on how trade is conducted across borders globally and Changes in currency exchange rates affect international trade by increasing or decreasing exports and imports.

As it stands, international trade is conducted in the currencies of major economic powers, largely the US dollar, European Union Euro, Japanese Yen, Chinese Yuan, and UK Pound Sterling. This has resulted  in foreign currency shortage across the African region as the demand for the major currencies exceed the available supply at the prevailing exchange rate.

Commenting on this,Gerald Ndosi, head of trade coverage at Bank One, a Mauritius- based full service commercial bank, said “Soberingly enough, over the last year, most countries in sub-Saharan Africa (SSA) have experienced shortages of US dollars. Every African country has felt the impact – however the problem seems to be more severe in economies such as Kenya, Tanzania, Egypt, Zimbabwe, Nigeria, Ghana, and Zambia that rely on the US currency to pay off their foreign debts and fund critical imports of goods and services.”

Ndosi pointed out that the shortage of the US dollar in key economies in SSA has meant liquidity challenges that can impact trade finance and affect the overall pace of economic activities in the region, catalysed by a few key factors including commodity dependence, limited export diversification, high import dependence and capital inflows/debt servicing burdens.

Dwelling further on the issue, the trade expert noted that  commodity dependence can affect the volume of dollars available in African markets, as many countries in SSA heavily rely on commodity exports, such as crude oil, minerals, and agricultural products.

“Fluctuations in commodity prices, which are often denominated in US dollars, can lead to revenue volatility, and affect the availability of US dollars in the local markets,” he added.

Ndosi also explained that limited export diversification means that the concentration of exports in a few commodities or markets can limit foreign exchange earnings in US dollars.  He explained that the lack of export diversification makes economies vulnerable to external shocks and reduces the inflow of US dollars, affecting liquidity in the local markets.

According to the Bank One head of trade coverage, high import dependence, which implies that sub-Saharan African countries often rely on imports for various goods and services ,including essentials like food and fuel, can translate to a shortage of dollars as well.  He added that the need to pay for imports in US dollars puts pressure on their demand, especially when local currencies depreciate, or foreign exchange reserves are insufficient.

“Economic sanctions imposed by Western countries on Russia, including restrictions on its energy sector, have contributed for the bulk of global oil price hikes over the last year, thus fuelling pressure on oil importing countries to source more dollars for import bill settlement,” he said.

With SSA having experienced an exodus of capital due to factors like global economic conditions, changes in investor sentiment, and policy uncertainties, Ndosi noted that capital outflows and debt servicing burdens has led to a dollar drain in the sub-Sahara, further straining dollar liquidity in the region.

Ndosi further noted that limited access to international financial markets can compound the problem, as it means that some countries in SSA face challenges in accessing international financial markets and raising funds in US dollars.

On how African economies can overcome the challenges and promote trade finance, Ndosi said addressing these pressing challenges arising from the prevailing US dollar shortage and ensuring sustainable trade finance requires a mixed approach.

To this end, the trade expert stated that encouraging diversification of economies beyond commodities can reduce reliance on volatile export markets and enhance foreign exchange earnings, including US dollars. He added that promoting value addition in exports and expanding export markets can increase foreign exchange earnings in US dollars and reduce import dependence.

Another strategy highlighted by Ndosi is the enhancing of local currency liquidity and financial institutions through effective monetary policies, exchange rate stability, and deepening the local financial markets. This, he explained,  can reduce dependence on the US dollar for domestic transactions.

“On a related note, strengthening local financial institutions in Africa is essential for sustainable trade finance. By enhancing their capabilities and expanding their reach, these institutions can better support trade activities, provide liquidity, and facilitate financing options denominated in local currencies,” he added.

Ndosi also advised on the promotion of regional economic integration and intra-regional trade to facilitate trade settlements in local currencies and reduce reliance on the US dollar for regional transactions.

“Here, African countries may explore using local currencies or regional currencies, such as the African Continental Free Trade Area (AfCFTA) digital currency, to facilitate intra-African trade. This would reduce reliance on the US dollar and mitigate the impact of US dollar liquidity challenges,” he stated.

Strengthening domestic financial institutions, improving risk management frameworks, and encouraging innovation in financial services were also identified as strategies that can enhance the resilience of the financial sector and promote trade finance,reducing the need for US dollar-based transactions and minimising associated liquidity challenges.

Ndosi also stressed that collaborating with international partners, including multilateral development banks and foreign investors is critical, as they can provide support through technical assistance, investment, and capacity building to address US dollar liquidity challenges in SSA.

“Further, Development Finance Institutions (DFIs) such as the African Development Bank and regional development banks, can play a crucial role in providing trade finance facilities to bridge the liquidity gap. These institutions can offer financial products tailored to African businesses, mitigating risks associated with US dollar liquidity challenges and supporting trade activities,” he added.

On an overarching note,Ndosi opined that  technology-driven innovations, such as blockchain and digital currencies can offer alternative solutions for trade finance in Africa. According to him,blockchain-based platforms can facilitate secure and transparent trade finance transactions, while digital currencies can streamline cross-border payments and reduce dependence on US dollar liquidity.

“Indeed, through currency diversification, regional integration, and collaborative efforts, suitably synergised by technological innovations, African countries can navigate the challenges and seize opportunities to promote trade, economic growth, and financial stability within the continent,” he concluded.