By Bright Simons/The Africa Report
African leaders have called for repatriating 30% of the continent’s foreign reserves held overseas. Is this a good idea?
African Union (AU) summits are not noted for their blockbuster announcements and headline-grabbing new ideas, but there are exceptions. In recent times, they have been the forum for the unveiling of such grand affairs as the AU passport and the single continental market, AfCFTA.
Visionary
One of the glitzy new ideas at this year’s event was the call by Ghana’s President for the continent to repatriate 30% of its reserves held overseas. It was re-featured in an op-ed in this week’s edition of The Economist magazine co-authored by the Presidents of Zambia, Kenya and Ghana. Some have hailed it as both visionary and revolutionary.
Is it? The devil is in the detail.
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First, it is important to make several nuanced distinctions. Ghana’s President is talking about “official forex reserves”, that is to say, “central bank savings”, with nothing to do with private money. He is also talking about more than just cash since official reserves also include things like treasury bills and bonds of foreign governments, gold, and even occasionally the bonds of private companies.
“Reserves” do not usually include less liquid national assets overseas such as diplomatic holdings of buildings, sovereign wealth fund investments, and the equity of state-owned companies in foreign enterprises (for example, the Central Bank of Ghana owns a bank in London, and state-owned Ethiopian Airlines owns a variety of stakes in many companies abroad).
He is also probably more concerned about medium-term saving instruments like bonds, bills and fixed deposits (30% of Ghana’s reserves are in this form), than he is about more “current account-like” savings in banks in New York, Paris, London and elsewhere.
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The thing, however, is that all these nuances greatly complicate, and, in many ways, problematise the President’s call.
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Second, this call would have been more apt a decade and a half ago, in 2008-2009, when the then head of Afreximbank, an Africa-focused development finance institution (DFI), gave the same advice.
Africa’s reserves
At that time, Africa’s collective forex reserves exceeded $400bn, about 25% of the continent’s GDP then. Today, the number is hovering around $300bn (and dropping due to fiscal woes in some major economies), barely 10% of continental GDP. In 2008, Africa’s reserves outstripped India’s, today they are just a little over half of tiny Taiwan’s.
Indeed, the declining stock of international reserves means that when activist groups like Oxfam compute detrimental capital outflows from Africa, they assign zero impact to the reserves category. The problem, if it is one, is significantly less concerning now than in the past.
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Third, the structures to “receive” these amounts “back home” are not very ready. The president suggests that African-focused DFIs can use the roughly $100bn that would be unlocked to fortify their capital. He does not seem to have given sufficient thought to the purpose of these reserves.
The bulk of them are for risk management and precautionary purposes. Ghana, for instance, burnt through 60% of its reserves very rapidly as its recent fiscal crisis deepened throughout 2022.
One requires reserves to be held in the safest, most liquid, form, hence the current preference for treasuries, bonds, and bills of the richest and most stable economies, like the US, Germany, Japan and the UK. Not only are financial products minted in these places considered and rated safe and liquid, but the absence of capital controls also makes it easy to liquidate and move assets around very rapidly.
Hassle-free liquidation
Central Banks in Africa often have to make various forex-dominated payments overseas on behalf of the governments and need similar corresponding banking relationships, just like commercial banks, to do so (in Ghana’s case, such arrangements constitute ~20% of reserves). Thus, even gold is usually best stored in certified form in international vaults where liquidation can be quick, secure and hassle-free.
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Should African central banks move large portions of their stock of reserves to African DFIs like AfDB and Afreximbank, they will require that the same conditions be met. AfDB and Afreximbank will end up keeping the bulk of these forex “deposits” in banks in the same jurisdictions and similar AAA-rated assets as before.
The “problem” would thus remain unsolved. Unless Africa develops more super-safe saving instruments through the coordination of sound macroeconomic governance and financial sector development, the tendency of prudent managers to opt for financial instruments minted elsewhere will remain.
Ghana, for instance, burnt through 60% of its reserves very rapidly as its recent fiscal crisis deepened throughout 2022.
It is not just African countries that keep a lot of their reserves overseas. Outside those countries whose domestic currencies are also global reserve currencies, most countries hold their reserves in rich, stable, economies.
Chile, for example, invests virtually 100% of its forex reserves through Merrill Lynch and Bloomberg Barclays Capital index-linked funds in North American and European bonds and treasuries.
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The Bank of Israel’s basic benchmark portfolio is likewise composed of US and European treasuries, with returns falling to near-zero for long stretches – Israel’s forex holdings are about 70% that of Africa as a whole. More than 80% of Colombia’s foreign exchange reserves are in US treasuries and bonds.
Hold foreign currency assets
Turkey’s foreign exchange reserves policy exhibits similar conservatism. Reserve currency primacy means that even a rich and stable country like Switzerland, which holds reserves equivalent to 91% of GDP, ends up holding the vast bulk of it in foreign investment instruments.
Since the usual point of forex reserves is to hold foreign currency assets, whether the goal is to have the means to bolster the value of the local currency when necessaryor to support commerce when local merchants cannot access enough forex from local banks, the Ghanaian President’s complaint about low returns somehow misses the mark.
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Those returns map to the level of risk. Local currency returns are usually higher only because they are riskier and subject to more exchange rate volatility. Repatriating dollars, for instance, to Ghana or Nigeria in the hopes of earning cedi or naira returns is simply incongruous. Indeed, highly restrictive investment mandates are the hallmarks of central bank foreign exchange reserve portfolio design.
Governments in Africa often have to stock up on forex because compared to the emerging market average of 11% of GDP, the African private sector’s foreign currency asset position is in the region of 3% of GDP.
For longer-term “national savings”, such as sovereign wealth fund holdings, the dynamics are somewhat different, though surprisingly similar in important respects.
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There are indeed African sovereign wealth funds that keep most investments locally. Ethiopia is one, but that is mainly because the investments (not “reserves”) are mostly in the form of stakes in state-owned companies. Ghana is one of those countries that outrightly bar some of its sovereign wealth vehicles from investing locally.
Repatriating dollars, for instance, to Ghana or Nigeria in the hopes of earning cedi or naira returns is simply incongruous.
Even with sovereign wealth funds, and other subsets of state-owned investment vehicles, there could be justifiable reasons for investing primarily overseas, for risk management purposes. One such reason is prudential “diversification”. By spreading investments in overseas jurisdictions, one assures uncorrelated returns in times when some markets (including the home country) are undergoing crisis.
Singapore, for instance, invests 74% of its sovereign wealth funds overseas. It does so also because, during their research, the funds may identify highly lucrative sectors that are simply better developed elsewhere than at home.
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For similar reasons, only 9% of Middle Eastern sovereign wealth resources are invested domestically: Europe, Australia and North America receive a combined share of ~62%. Furthermore, in that same line of analysis, many sovereign wealth funds are set up to unlock more investment from overseas.
Overseas investors
Building relationships with overseas investors sometimes requires co-investment in various opportunities. It is more likely that such co-investments will initially target international prospects. This has been the experience of Gulf and Middle Eastern sovereign funds, who today own everything from football clubs to signup rights for individual sportsmen in Europe and America.
If the main goal is to ensure the safety of the assets and avoid dissipation, as in the case of Ghana’s petroleum funds, the lack of local super low-risk assets will obstruct the goal of investing in intergenerational national wealth locally, especially, in the wake of domestic debt defaults.
On closer examination, the call for reserves-repatriation sounds less obviously brilliant than it does at first. It certainly warrants much more technical deliberation, something it has yet to benefit from. The Ghanaian government hasn’t even initiated a proper policy dialogue in its own country. A position paper, at the very least, would be nice.