How the FX market could unlock intra-Africa trade

It is undisputed that SMEs are pivotal to driving economic growth in Africa, and that consumer spending, B2B spending, and export-led growth will be key engines for Africa’s growth over the next decade. While much of the attention has been focused on Africa’s consumer market, research shows that B2B spending and exports also have a substantial role to play.

In Nigeria, SMEs employ 84% of the active workforce, and in Kenya this number is 74%. These same SMEs are estimated to contribute at least 87% of new jobs created in the country, and job creation is closely associated with the growth of domestic spending, consumer confidence and disposable income – all instrumental factors for sustainable economic growth.

In fact, B2B spending is already greater than consumer spending and is expected to grow by 35%, with companies increasing their spending from $2.6 trillion in 2015 to $3.5 trillion by 2025. Half of this total is expected to be spent on materials, with the balance spent on capital goods, and a wide range of services.

Africa could expect to double its manufacturing output in just ten years. 75% of this growth is expected to come from meeting domestic consumer and B2B demand, and the balance could come from boosting exports for products that African economies are increasingly establishing their comparative advantage in, like cotton in Ethiopia, and flowers in Kenya.

This goes to highlight the significant role that trade will have to play in enabling growth on the continent, especially as intra-African trade begins to experience strong growth with the policy advances and improvements in infrastructure that have begun to take shape.

Although growing rapidly and posting 17% growth to $159 billion in 2018, the value of intra-Africa trade is comparably low next to other regional blocs like the EU. According to data from UNCTAD, intra-African exports represent only 17% of total African exports, compared to intra-EU exports of 68% and intra-Asia exports of 60%. This underscores the growth potential that lies ahead for intra-African trade as the continent moves towards the range of more developed regional blocs.

Despite this tremendous growth opportunity and the central role that African SMEs play, research shows that African SMEs are, on average, contributing less to their domestic economies than their counterparts in other parts of the world. SMEs contribute an average of 64% to global GDP; and where in China this number is over 60%, the average for emerging markets is only 35%.

While there are a host of challenges that negatively impact SME productivity, profitability, and their ability to access new markets, one factor that is seldom discussed is foreign exchange dysfunction. This has created both a need and an opportunity for alternative FX providers, who can step in to design new systems that are African-centric to address these challenges.

With currency volatility and unavailability, most suppliers demand that buyers pay for goods using dollars or other G10 currencies. However, in many African countries, the availability of US dollars is scarce, controlled centrally, and are distributed only to the largest companies or the politically connected, thus putting SMEs looking to source FX at a serious disadvantage.

In fact, small businesses in Africa often pay nearly 200% more than larger businesses to clear transactions through formal channels, and many transactions are conducted via cash as opposed to through formal payment channels.

A substantive amount of bank transfers originating in Africa (and also terminating in Africa) require the dollar as the intermediary settlement currency, resulting in transaction fees that could range anywhere from 3% to as high as 10%. For an SME, this cuts their margins even further, and hinders their ability to reinvest profits into growth and expansion.

Cross-border transfers take three days at best to be processed and, in some cases, as much as two weeks. Since SME supplier and partner relationships may be tenuous to begin with, this can put unnecessary strain on their operational relationships.

Finally, it is difficult to regulate and supervise cross-border payments as they are transacted via cash through the informal sector. Such black market transactions may be the only option for a number of SMEs, which furthers the amount of risk they must take on.

While these challenges have made it evident there needs to be emerging market-specific systems to empower SMEs across Africa, we also recognize that the incumbent system is deeply ingrained, and holding foreign reserves is pivotal for fiscal authority.

In 2019, the Afreximbank launched an innovative Pan-African Payment and Settlement System (PAPSS), a continent-wide system to enable payments in local currencies. As pointed out by Professor Oramah, the President of the Afreximbank, cross-border payments in Africa still involve a third currency (e.g. the US Dollar or the Euro) which leads to high transaction costs and long transaction settlement periods. PAPSS and similar solutions, which are built to facilitate the use of local currencies, are critical for the success of initiatives like the African Continental Free Trade Agreement.

In addition to solutions by the government, private companies have also started developing hybrid infrastructure that can contribute to the solution. For example, AZA was created to act as a hub, connecting middle-market frontier businesses to the rest of the world, through an API-led platform of European and other international banks, frontier market banks, and mobile money operators.

In doing this, the solution promotes the use of local currencies for international trade. This eliminates the use of US Dollars as an intermediate currency and will complement the efforts of financial services providers, including banks and telecom companies, to deepen financial inclusion by making FX available to underserved and unserved informal markets.

Most other financial players, like M-Pesa in East Africa, have also started looking at systems that can better facilitate cross-border exchange, but primarily at the consumer level. Remittances still account for a large proportion of GDP in many African countries. But the ability to transfer smaller amounts is only part of the picture.

At the end of the day, when discussing financial systems innovation, governments and private players need to come together, as topics such as foreign currency reserves and in-country liquidity are huge projects that need to be collaborated on.