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QE2 and Africa

Shanta Devarajan's picture

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).

Comments

Submitted by Leo F. on
Dear Shanta, I thank you for this helpful overview of relevant implications of QE2 for Africa. However, I want to make one objection regarding point 3. QE2 is not likely to lead to lower interest rates in the US, let alone higher capital inflows to SSA. The reason is quite obvious: US interest rates are already near zero. In a strict sense, the term 'QE' per definition refers to the extension of the FED's balance sheet, only if there is a situation where monetary policy has no significant effect on interest rates. In any other situation, we would not use the term 'QE', but rather refer to it as ‘business as usual’ (= open market operations). Therefore, the interest rate issue is a rather unimportant concern for SSA in the context of QE2. In contrast, I totally agree with your worries about the adverse effects of a 'currency war'.

Thanks very much for your comment, Leo. If QE2 has no effect on interest rates in the U.S., then why are the Europeans worried that the dollar will depreciate? It must be because they think interest rates in the U.S. will be lower than in Europe. Likewise, interest rates in South Africa, for instance, will be higher and capital will flow to where it can earn the higher return.

The idea behind QE2 is that it will keep down long term interest rates as the short term rates are up against the zero lower bound. The Fed is unable to reduce short term interest rates any lower than they are at present so it has had to resort to this unprecedented response in an effort to ease monetary policy. The likely extension of the Bush tax cuts and everything else that is being bundled in with that will act as a significant second large stimulus in the US, and ease concerns about the US economy experiencing a double dip recession. It is likely that the uncertainty generated by the fiscal crisis in the Eurozone will actually have bigger currency implications than QE2, and I believe that the Euro will therefore perform weaker than the US dollar over the next year as a result. CFA franc countries, pegged to the Euro, will benefit from weaker currencies which will increase the competitiveness of their exports. However, it will also make oil imports, which are quoted in dollars, more expensive and push up import and transport costs as a result.

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