The East African shilling currencies (Ugandan, Kenyan and Tanzanian) are going through a rough patch, losing value against both the dollar and the euro over the past year. The past couple of months have been especially hard on the Ugandan shilling (UGX), which has depreciated by almost 20 % against the Euro. This means, that if a Ugandan wanted to buy one euro in the beginning of June, it would cost him UGX 3,483 and today the cost would be around UGX 4,102. This drop in the value of a shilling has great impact on African business men and women, because it raises the cost of imports, which are often used as inputs into production (e.g. fuel and machinery). The increased production costs in turn lead to higher prices in domestic markets, which again affect African consumers by eroding their disposable income. In a country like Kenya, which imports large amounts of maize, the higher costs of importing may, therefore, have severe consequences for living standards.
The slide of the East African shillings also affects MYC4 investors around the world. How? When a MYC4 loan is disbursed to an African entrepreneur, this is done in the local currency of the recipient country (e.g. UGX), rather than in Euro. MYC4 follows this procedure in order to ensure that the African borrower doesn’t experience fluctuations in how much he or she owes MYC4 in the local currency. If MYC4 instead disbursed loans in Euro, the recent shilling depreciation would imply that a borrower receiving a loan of EUR 1,000 would one day owe MYC4 investors UGX 3,483,000 and one month later UGX 4,102,000 (not taking repayments into account). While local currency disbursement seems reasonable from the perspective of the borrower, the flipside of the coin is that MYC4 investors carry the entire currency risk. The shilling depreciation has, for example, meant that a Ugandan loan repayment of UGX 100,000 in the beginning of June was valued at approximately EUR 29. Today, the value would be approximately EUR 24, corresponding to a loss of EUR 5 due to currency fluctuations alone.
While MYC4 believe that our investors are better equipped at handling currency fluctuations, compared to our borrowers, who may at times be struggling to make a living, the recent Quarterly Portfolio Performance Report illustrated that currency is the main driver behind the small negative average return on recent MYC4 investments. In other words, had the shilling currencies not experienced this depreciation, investors would be making positive returns.
As we do have investors who invest with primary objective to earn a positive return, MYC4 wants to encourage these investors to take currency risk into account. This may be done either through demanding higher interest rates or through investing in countries with more stable currencies. As currency fluctuations have a great impact on investor returns, finding alternative ways of handling these fluctuations is a priority area of MYC4 moving forward.
So why are the shilling currencies depreciating and are there any signs of a rapid recovery? The currency market is, as any other market, governed by the forces of supply and demand. Recently, the high growth in most East African economies has meant that the demand for imports has increased. The reason is that higher disposable incomes in Africa result in African consumers demanding more imported goods. These goods must be purchased with foreign currency, such as Dollars or Euros, which implies that the African demand for holding such currencies has increased. At the same time, the financial crisis has meant that European and American consumers aren’t importing as many African goods, and their demand for holding African currencies has, therefore, declined. Similarly, foreign capital flowing into Africa is contracting. Together, these effects imply that African currencies are simply less in demand compared to Euros or Dollars in the currency markets. The expectation of future large exports of natural resources, such as oil and gold, may provide a light at the end of the tunnel for the East African shilling currencies and recently, the Kenyan Central Bank has increased interest rates with the purpose of making Kenya a more attractive destination for foreign investors and dampening the currently high inflation.
Written by Marianne Hvidt, MYC4 Operations Assistant