Our analysis suggests you should own the Ugandan shilling and the Ghanaian cedi (post-election) vs nine other African currencies that we looked at, because we view them as undervalued and most likely to appreciate. You should avoid the overvalued Angolan kwanza, Ethiopian birr and Nigerian naira, as we think they have further to fall. We are more constructive on the Kenyan shilling, as long as monetary easing is held off (which we expect).
Why you should own the Ghanaian cedi and Ugandan shilling
If you want to buy a fairly valued African currency, we think you should buy the Rwandan franc (RWF), which on our estimates has traded close to its fair value since 2013, according to real effective exchange rate (REER) analysis that this analyst developed, by measuring the trade-weighted exchange rate vs a basket of currencies after adjusting for inflation differentials. We take the fair value to be the FX rate implied by a currency’s long-term average REER. We argue that an undervalued currency in a country with positive real interest rates, owing to tight(ening) monetary policy, is most likely to appreciate over the next 12 months. Of the 11 African currencies we looked at, we found that the Ghanaian cedi (GHS), after the December elections, and Ugandan shilling (UGX) fit these criteria (see Figure 1). Uganda cut its policy rate by 1 ppt in April, but it still has one of the highest positive real interest rates in the region (11%). However, deeper rate cuts in Uganda would undermine the UGX.
Why you should avoid the naira, kwanza and the birr
We suggest avoiding overvalued currencies in countries where the monetary authority is inclined to loosen policy or where real interest rates are negative, such as the Angolan kwanza (AOA), Ethiopian birr (ETB) and the Nigerian naira (NGN). Of these three, we see the AOA as the most expensive. The FX rate implied by its long-term average REER is AOA251/$, vs a rate of AOA166/$ on 29 April. The AOA is made more vulnerable by Angola’s deep negative real interest rate (-9.1%). The recent softening of inflation in Ethiopia has helped to make real interest rates less negative, but we think inflation is likely to have bottomed and rates will likely stay put. In Nigeria, we see inflation continuing to accelerate owing to fuel and FX shortages (we forecast inflation of 16.7% at YE16), and we project a further 4-ppt interest rate hike this year (to 16% by YE16). This implies interest rates are likely to remain negative or, at best, just slightly positive. We think there is also a risk that weak growth could limit rate hikes. It is for these reasons we think the NGN – with an FX rate implied by its long term average REER of NGN255/$ – is at high risk of depreciating.
When could the KES become vulnerable?
The Kenyan shilling (KES) is also overvalued, according to our REER analysis, but we think it is well supported by firm monetary policy. Positive real interest rates and the build-up of FX reserves, to a record high of five months of import cover, explain why we have become more constructive on the KES. We now see it weakening only to KES105/$ at YE16, vs the FX rate implied by its long term average REER of KES119/$. We think the KES could become vulnerable if monetary policy were eased (not our base case – we forecast a flat central bank rate at 11.5% until YE16).
