By holding part of their foreign exchange reserves in African currencies, African countries could boost trade within the continent, says Okey Umeano
This article was first published in the February/March 2019 Africa edition of Accounting and Business magazine.
I believe the time has come for African nations to start holding African currencies in their reserves. Foreign reserves are assets controlled by a country’s monetary authorities for exchange rate management, meeting balance of payments financing needs, and other uses. For many countries, they are used to send a signal – to reassure trade partners and investors about the country’s ability to meet its obligations to them – as well as acting as a store of wealth for nations.
The major reserve currencies are primarily the US dollar and euro, although sterling, the yen, the Swiss franc, the Canadian and Australian dollar, and renminbi also figure. International Monetary Fund data on the composition of foreign exchange (FX) reserves has a catch-all category called ‘others’; in Q3 2018, these ‘other’ currencies accounted for a meagre 2.5% of the world’s total allocated reserves.
Countries typically hold non-reserve currencies for trade and other practical purposes. For instance, if many residents of a country make the annual pilgrimage to Mecca, the central bank may hold Saudi riyals for their use even though the riyal is not a reserve currency.
Last year, 44 of the African Union’s 55 member states signed yet another trade deal, setting up the Continental Free Trade Area (CFTA). If central banks in Africa started holding each other’s currencies in their reserves, it would oil the CFTA wheels and demonstrate members’ confidence in each other’s economies. It would also make governments more accountable, as they would know that central banks that hold their currency could dump it in the event of mismanagement.
How much of each currency to hold could be left to the central banks to decide, based on the volume of trade between individual countries. An orderly way to go about it might be to construct a basket of member countries’ currencies weighted according to GDP and trade flows. Participating central banks could then undertake to hold no less than 5% of their reserves in this basket. The basket could take into account all the usual issues of trade, convertibility, size of the economy, macroeconomic factors, etc, to find the sweet spot of an acceptable mix. For reserve managers hesitant about holding volatile emerging market currencies, the diversification effects of the currency basket would greatly reduce the downside risk.
To further manage the risk, the rules for inclusion in the basket should target behaviour required of participating currencies, with targets for money supply, inflation and currency management. Such rules would help make governments and central banks responsible and accountable, and rein in reckless monetary policies, as not meeting the guidelines would mean being booted out of the programme.
On its own, signing agreements for trade and cooperation is not a silver bullet. African nations also need to show faith in each other, and start getting intra-African trade moving.
Okey Umeano is head of risk management at Nigeria’s Securities and Exchange Commission.
"Trade agreements are not a silver bullet. African nations also need to show faith in each other "