European debt crisis adding to dangerous African volatility

Europe's debt crisis and the on-again off-again fears that a member of the eurozone will default on its obligations are adding to market volatility in Africa, which in turn is contributing to the hardships of the continent's poorest. While African stock markets fluctuate up and down in response to news from Frankfurt and Brussels, currencies are also ebbing and flowing in response to European currents.
When investors worry, capital flies back to home bases in Western markets, negatively affecting emerging economies. "Spillover risks from the financial and economic woes in the euro area periphery have intensified, and, with weakened growth and sluggish transition from public to private demand in the United States, there are concerns about an upsurge in financial volatility," the governor of the Nigerian central bank, Malam Sanusi, said this week.
Central bank governors from Kenya, Uganda, Rwanda and Tanzania met in Nairobi on Wednesday to try and co-ordinate a way to tackle the twin problems of rising inflation and volatile foreign exchange markets. With the exception of Rwanda, the East African nations are all seeing double digit inflation.
Local factors also play a role. Kenya's shilling has collapsed in recent weeks, with analysts pinning much of the blame on domestic policy makers. Both Nigeria and Kenya aggressively used interest rate hikes to support their currencies, but markets reacted differently, seeming to prefer Abuja's response.
"Nigeria was more consistent with informing the markets," says Nema Ramkhelawa, an analyst at Rand Merchant Bank in South Africa. She noted also that Nigeria refrained from using too many financial tools and complicating matters. That did not happen in Kenya, where analysts say the central bank hesitated for too long before taking action and then did so in a complex way that spooked investors.
South Africa's rand was regaining lost ground this week, after the currency took big hits last month versus the dollar and the euro, on sentiment that Europe was moving closer to resolving some of its key problems. The rand is a particularly liquid currency by African standards and therefore can be extremely vulnerable to external shocks.
The effect of the rapid movements can be devastating on the poorest in developing African countries, especially when unemployment remains stubbornly high. South Africa, the largest economy on the continent, has shed over 1 million jobs as a result of the global economic downturn and is struggling to create new work, leaving unemployment close to a shocking 26 per cent.
Kenya too is struggling to create employment, as its urban slums continue to grow in size. The interest rates hikes will also make it harder for the government to borrow and finance key projects to battle poverty. "Life has been very difficult, especially after prices of essential commodities shot through the roof," Mary Akoth, a slum dweller in Nairobi told the Standard newspaper.
The UN Food and Agriculture Organisation warned that on top of drought affecting parts of East Africa, "high food and fuel prices have placed an additional strain, forcing families to eat fewer meals a day or to sell off livestock." Ramkhelawa says it is important that the government in Kenya get on top of the shilling, to contain its decline and bring import inflation under control.
"Sentiment is very fragile in Kenya at the moment. We need a firm stance by the central bank to restore faith," she told dpa. Foreign investment remains crucial to Africa. Even Ghana, with one of the highest growth rates in the world - provisional estimates see GDP expanding by 13.6 per cent in 2011 - is still struggling to attract offshore purchasers for its bonds.
With a steady flight to safety over recent months by foreign investors, analysts say it is unlikely that they will go long on Ghana bonds when immediate liquidity is the overriding concern. If Europe reaches a concrete deal on its debt issues, investors will be more willing to take on risk in emerging markets in Africa, they believe. On the other hand, South Africa and some other countries worry that "hot" inflows of foreign capital can create wild swings, which can also hurt the economy. "Once offshore volatility settles, we can judge what is happening locally better," Ramkhelawa says. And then investors can judge which African central banks and governments handled the crisis best.