Several people have been asking about the implications for Africa of the U.S. Federal Reserve Bank’s decision to buy $600 billion in bonds—known as “quantitative easing 2”. Four points:
1. Notwithstanding all the criticism, there is a chance that QE2 might work, stimulating the American and thereby the global economy. Africa would unambiguously benefit from this “upside” scenario.
2. There is also a chance that, by depreciating the value of the U.S. dollar, QE2 would trigger a currency war with other large economies. This would be an unambiguous disaster, and Africa will suffer, along with the rest of the world.
3. Between these two extremes is the possibility that lower interest rates in the U.S. will prompt capital to flow to other countries, including some African countries. This would in turn cause these countries’ exchange rates to appreciate, making their exports less competitive.
With the exception of South Africa, most African countries do not receive large capital inflows. Furthermore, most of them can—and do—adjust their exchange rate to maintain export competitiveness. The exceptions are countries such as Lesotho who, as my colleague Ashish Narain points out, have no control over their monetary or exchange rate policies (their currency is pegged to the South African Rand), or those of the CFA Franc zone, whose exchange rate is pegged to the Euro. These countries will see their exchange rates appreciating because of capital flowing to other countries: they don’t benefit from the capital inflows, but bear the cost of an appreciated exchange rate.
4. In South Africa, there is concern that QE2-induced capital inflows will cause the Rand to appreciate and undermine export competitiveness. But, as my other colleague Sandeep Mahajan suggests, the problem may not be capital inflows per se, but what they are financing. We normally think of capital inflows to developing countries as a good thing—these countries need capital to finance investments in infrastructure and other types of productive capital. The challenge for South Africa is to make sure these flows finance productive investment and not consumption, such as cars. There could be ways of adjusting prudential regulations so that banks are encouraged to lend for investment over consumption. Then South Africa could benefit from the capital inflows, much as the East Asian countries did (and the Latin American countries—who used inflows to finance consumption—didn’t).