Making sense away from dollars

| Friday June 14, 2013 00:00

Businessweek: Kindly clarify the point you made at the conference on the need for Africa to move away from reliance on the US dollar as a base currency?

Visser: Currencies are always quoted as a cross rate, i.e. the 'price' of one currency relative to another. But this price is as much a reflection of the numerator (e.g. Botswana Pula) as it is of the denominator (e.g. the US dollar) - if there is a change in the BWP/USD rate, it is not always clear if that change reflects change in Botswana (Pula) or change in the US dollar. This is most evident on days when the local market is closed for business, yet the currency cross rate still changes, due to change in the US$. Thus consider a situation that affects the fundamentals of the US dollar (e.g. the US$ falls by 10 percent), but not the fundamentals of Africa, or a region such as SADC.  In this case both the BWP/USD rate and the ZAR/USD rate will reflect the same changes in the USD (BWP/USD and ZAR/USD both gain 10 percent), but there will be no change in the BWP/ZAR rate! The use of the US dollar (or any other 'foreign currency for that matter) as the base currency in Africa introduces the effect of fundamental factors that has nothing to do with Africa, into the equation. This adds unnecessarily to costs - both direct (spot rates) and indirect (hedging).

Businessweek: What impact does using the US dollar as a base currency have on cross-border currency trade and goods trade in Africa?

Visser:There is both a direct and an indirect impact.

Direct: Cross-border trade in goods and services within Africa is often priced in US$ and also paid for in currencies that reference the US$. For example, if a Nigerian business wants to buy goods from a Kenyan supplier, the quote will be either in US$ or in Kenyan Shillings. Whilst there is limited direct currency trading available between the NGN and the KES, the Nigerian business requires two currency transactions: sell Nigerian Naira to buy US$ and sell US$ to buy Kenyan shillings. This introduces additional costs: double the transaction costs, 'crossing the double' twice (you buy at the offer price and you sell at the bid price), and should hedging be required, the individual volatilities of both the NGN/USD and the KES/USD rates have to be priced into the hedging strategy.

Indirect: If goods and services are priced in US$ terms, these prices are directly affected by what happens in the US$ currency market, and also by the fundamentals of America. This is very visible in the prices of commodities/resources. For example, when the US$ strengthens due to capital inflows into the US market, the price of gold, oil and so on fall in US$ terms, for reasons that might have nothing to do with the fundamental demand for the commodities. This affects the value of transactions in local currency terms.

Businessweek: Kindly repeat the example you gave of currency trade between Botswana and South Africa, on the costs associated with basing these on the US dollar.

Visser: Most forex/currency trading desks are US$-based. This means that any cross-currency transaction is executed 'through' the US$ as explained above. Over the past three years, the volatility of the ZAR/USD rate has been plus/minus 15 percent per annum, whereas the volatility of the BWP/USD rate has been plus/minus 10 percent per annum. This means that currency trade between the ZAR and the BWP, if done via the US$, will incur costs associated with plus/minus 25 percent volatility (15+10 percent), whereas the volatility of the direct BWP/ZAR rate has been less than 7 percent per annum over this same period. Theoretically speaking, the cost of the currency transaction is  plus/minus three to four times more expensive than it would be if the US$ was eliminated!

Businessweek: What are the origins of the usage of the US dollar as a base currency?

Visser: This is not my area of speciality, but I would suggest that after the demise of the gold standard for currencies (post Bretton-Woods), the currency of the dominant world force (in terms of global GDP and trade flow) became the de facto reserve currency of the world - that is, the US dollar.

Businessweek: You have said the fact that Africa is resource-rich does not mean everyone participates in the wealth creation process. Kindly elaborate.

Visser: Mining and exploration is a capital-intensive industry and one that requires highly-skilled resources, including financial and investment skills to assess the risks associated with particular projects and the industry in general. The JSE Securities Exchange has a long history associated with mining, as it was, in fact, founded on gold mining companies (and) to this day, the equity market in South Africa continues to be dominated by a few mining giants, such as Anglo American and BHP Billiton. However, when one takes a further look north and scrutinises the listed companies on the stock exchanges of the rest of the African continent, you will notice that very few metals and mining, resources or commodities companies are listed. This is despite the fact that Africa is recognised as one of the richest sources of minerals, precious metals and gems in the world.

In fact, one has to look much further afield to the stock markets of London, Toronto and Australia to find listings of the companies that are involved in mining operations on the African continent. Although the invested capital flows through to the companies and mining operations in Africa, none of the return on that capital accrues to the locals. Participation in the wealth-generation process is restricted to those investors that can access the listings in foreign markets. Individual investors need to have some serious money available for investment before this is an option for them, and although institutional investors such as pension funds are allowed to invest in foreign markets, all of the spin-off benefits within the financial services industry accrue to the foreign capital market and none to the local market.

This is akin to raw materials being exported from the African continent, the beneficiation of those materials being undertaken in other markets, only for the final product to be imported back to the country of origin - obviously at a much higher price!

Businessweek:How do ETFs ameliorate this situation?

Visser:By creating ETFs on these African mining stocks and making them directly available to investors across the continent's stock exchanges, it will provide the opportunity for the entire spectrum of investors - from pension funds to retail investors - to participate in the benefits and wealth created by Africa's natural resources.At the same time, trading in these instruments in the local markets can go a long way to developing the stock exchanges and related financial services industries in these markets. This will broaden the investor base for the listed companies and allow a better spread of the wealth generated, without any sacrifice or penalty required from the current investors. It truly offers a win-win solution to investment in and for Africa!

Businessweek: Does Nedbank have any future plans for the Botswana Stock Exchange (BSE) or the Botswana market?

Visser: Nedbank Capital continues to engage with the BSE and the Botswana market to facilitate growth of the financial services industry and broaden the investor base. To this end we recently assisted the BSE in the development of its own series of bond indices to measure the performance of the domestic bond market - both sovereign and corporate.  We are currently in discussions with local asset managers and asset consultants to identify concerns around the existing equity indices calculated by the BSE, with the aim to propose changes that would make these indices more appropriate in the setting of mandates and performance benchmarks, and would be a more accurate reflection of the investable opportunity set for investors on the BSE.