Monitoring emerging market currency shortfalls

The lack of hard currency greatly hinders international trade activity by obstructing the exchange of goods and services. We assess the risk of foreign exchange shortages in four emerging countries: Egypt, Bangladesh, Nigeria and Argentina.

Egypt

During the second mid-2023 and early 2024, importing businesses in Egypt struggled to mitigate the impact of the Egyptian authorities’ foreign currency rationalization, effective from the summer of 2023. Access to foreign currency turned positive in March 2024, after a consortium led by ADQ, one of Abu Dhabi’s sovereign wealth funds, has pledged to invest $35 billion in the development of Ras El Hekma, a future tourist resort on Egypt’s northern coast. Initial flows under this program stabilized Egypt’s foreign exchange reserves, coinciding with the International Monetary Fund’s (IMF) upgrade of Egypt’s support package to $8 billion later in March 2024.

The combination of these events provided enough currency cover for Egypt’s central bank to allow the Egyptian pound to depreciate against the US dollar, using a 600 basis point (bp) increase in the key policy rate to prevent inflationary pressures from depreciation of the Egyptian pound and to discourage future financial outflows.

Such a major positive change in the availability of hard currency in a stressed country is relatively rare.

We assess that Egypt will continue to reduce its foreign currency shortfall risks. This reflects likely progress in the implementation of structural reforms as foreign investment momentum continues to improve. Further de-risking is likely to be supported by additional inflows from ADQ’s US$35 billion benchmark investment.

The continued improvement will lead to further clearing of import backlogs and easing of restrictions on foreign currency transactions, while potential capital flight is likely to ease as investor and consumer sentiment improves. Higher reserves would also support the import coverage ratio and help cover Egypt’s short-term external financing needs.

We see an underlying risk of renewed foreign exchange shortages in Egypt if the government fails to implement structural reforms and intervenes again to set a non-market exchange rate, if domestic energy shortages lead to prolonged and substantial import needs that drain foreign exchange resources or in the event of a regional escalation of the Israel-Hamas war.

Nigeria

Nigeria’s external position is improving, driven by a recovery in oil and natural gas production, complemented by robust remittance inflows, increased portfolio inflows, increasing multilateral financial support and policy reforms.

Since President Bola Tinubu assumed office in May 2023, various policies have improved the functioning of the foreign exchange market. These regulations require financial institutions to adhere to a cap on foreign currency holdings, reducing opportunities for speculative “hoarding”. Banks must also maintain a healthy level of high-quality liquid assets in each significant currency to ensure that they can easily cover foreign currency transactions.

The Central Bank of Nigeria (CBN) is also pursuing a more orthodox monetary policy by gradually increasing the policy rate to address inflationary pressures and ensure price stability. We project that total capital imports into Nigeria will improve, driven by foreign portfolio investment attracted by high interest rates and the tighter stance of the Monetary Policy Committee. Foreign capital inflows are also likely to be encouraged by the easing of monetary policies undertaken by major central banks.

Several risks will continue to threaten Nigeria’s foreign exchange position. These include weak governance, low non-oil revenues, high dependency on hydrocarbons, security challenges, high inflation and some ongoing exchange rate deficiencies. If reforms stall or social and political challenges force the Monetary Policy Committee to preemptively ease monetary policy, a potential consequence of recent civil unrest, international portfolio investors could reduce their exposures, triggering capital outflows.

Bangladesh

Bangladesh’s foreign exchange shortage stems from a sudden and sharp deterioration in its external liquidity position in 2022, reflecting the country’s high sensitivity to global price shocks exacerbated by the Russia-Ukraine conflict. The substantial increase in energy import costs has led to a sharp deterioration in the current account deficit, putting increasing pressure on foreign reserves and the taka exchange rate.

Foreign reserves fell from a high of $47 billion in August 2021 to just over $18 billion by April 2024 as Bangladesh Bank defended the taka’s value. The widening divergence between the official and parallel market rates also led to a sharp decline in remittances through official channels, exacerbating the US dollar shortage and triggering import restrictions and capital controls. Companies report persistent delays in securing trade finance and restrictions on opening letters of credit.

We anticipate the severity of the foreign exchange shortage to diminish gradually, provided political stability is restored soon after the recent social unrest and the sudden resignation of former Prime Minister Sheikh Hasina on August 5, 2024. However, downside risks to this The outlook has intensified since Hasina’s resignation, and we expect Bangladesh’s US dollar shortage to persist over the one-year outlook horizon. Prolonged political crisis or social unrest could significantly reduce exports, keeping pressure on foreign reserves and prolonging the foreign exchange shortage. Even if political stability returns, further currency liberalization may be limited by higher inflation, while the gradual removal of import restrictions will increase import demand, likely leading to a deterioration in the current account.

Argentine

Argentina imposed capital controls during the 2019 presidential election process and has failed to limit substantial distortions in its foreign exchange market despite securing a $44.5 billion IMF stand-by program. Argentina has a complicated system of multiple exchange rates. The country’s weak external liquidity position has been exacerbated by severe drought, reducing agro-export earnings by more than 40% in 2023.

In its first eight months, the government of President Javier Milea has made progress in key areas aimed at facilitating the eventual formal dollarization of the economy. The current administration reversed Argentina’s deep fiscal deficit to a surplus. It also reduced the interest-bearing liabilities of the central bank and increased the country’s foreign reserves. The government has pledged to maintain a 2% monthly devaluation and the preferential export rate system in place for the third quarter of 2024, even with the peso’s substantial appreciation in real terms.

Argentine farmers have traditionally kept a sizeable stock of their production from the previous harvest, usually to reduce revenue losses due to high inflation and the depreciation of the local currency. This remains the case in the absence of a market-determined exchange rate for their sales: exporters have no incentive to sell their stocks in the short term, given the clear likelihood of obtaining more attractive rates following deferral.

The outlook for 2025 for the export sector is positive, although agricultural commodity prices are expected to decline. The return of the La Niña weather pattern increases downside risk for the 2024-25 agricultural crop season. We estimate that if Argentina were to dollarize in December 2025, following the current strategy of issuing new public sector debt or raising new loans to cover the existing interest-bearing liabilities of the Central Bank of Argentina, the exchange rate would be approx. 2,200 pesos. per $1, assuming the central bank would buy all peso currency in circulation using its foreign reserves and assets.

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Editor’s note: The abstracts for this article were chosen by the editors of Seeking Alpha.