African Union (AU) summits are not known for their blockbuster announcements and headline-grabbing new ideas, but there are exceptions. In recent times, it has been the forum for unveiling such major cases as the AU passport and the continental single market, the AfCFTA.
Dreamer
One of the bright new ideas at this year’s event was the Ghanaian President’s call for the continent to repatriate 30% of its reserves held abroad. It appeared again in an article in this week’s edition The economist magazine co-signed by the Presidents of Zambia, Kenya and Ghana. Some hailed it as visionary and revolutionary.
Is? The devil is in the details.
First, it is important to make various shades. The President of Ghana talks about “official foreign exchange reserves”, i.e. “central bank savings”, with nothing to do with private money. It also talks about more than cash, as official reserves also include things like Treasury bills and foreign government bonds, gold, and even the occasional private company bond.
“Reserves” typically do not include less liquid national assets abroad, such as diplomatic building holdings, sovereign wealth funds’ investments, and state-owned companies’ shares in foreign enterprises (for example, the Central Bank of Ghana has a bank in London, and the state-owned Ethiopian Airlines holds varying stakes in many companies abroad).
He is also probably more concerned about medium-term savings instruments such as bonds, bills and fixed deposits (30% of Ghana’s reserves are in this form), rather than more “current” savings in banks in New York, Paris. , London and elsewhere.
The point, however, is that all these nuances greatly complicate and, in many ways, trouble the President’s call.
Second, this call would have been more apt a decade and a half ago, in 2008-2009, when the then head of Afreximbankan Africa-focused development finance institution (DFI), gave the same advice.
Africa’s reserves
At the time, Africa’s collective foreign exchange reserves exceeded $400 billion, about 25% of the continent’s GDP at the time. Today, the figure hovers around $300 billion (and falling due to fiscal problems in some major economies), barely 10% of the continent’s GDP. In 2008, Africa’s reserves surpassed India’s, today they are just over half of tiny Taiwan’s.
Indeed, the declining stock of international reserves means that when activist groups such as Oxfam calculate damaging capital outflows from Africa, they attribute zero impact to the reserves category. The problem, if it is one, is much less of a concern now than it was in the past.
Thirdly, the structures to “receive” these amounts “back home” are not very ready. The president suggests that Africa-focused DFIs can use the roughly $100 billion that will be unlocked to boost their capital. He doesn’t seem to have thought enough the purpose of these reserves.
Most of them are for risk management and preventive purposes. Ghana, for example, burned through 60% of its reserves very quickly as its recent fiscal crisis deepened in 2022.
One demands that reserves be kept in the safest, most liquid form, hence the current preference for Treasuries, bonds and bills of the richest and most stable economies, such as the US, Germany, Japan and the UK. Not only are the financial products produced in these places considered and rated as safe and liquid, but the absence of capital controls also makes it easy to liquidate and move assets very quickly.
Hassle-free clearance
Central banks in Africa often have to make various payments abroad on behalf of governments and need similar counterparty banking relationships, just like commercial banks, to do so (in the case of Ghana, such arrangements account for ~20% of reserves) . So even gold is usually best stored in certified form in international vaults where clearing can be quick, secure and hassle-free.
In the event that African central banks transfer large portions of their reserve to African DFIs such as AfDB and Afreximbank, they will require the same conditions to be met. AfDB and Afreximbank will end up holding most of these forex “deposits”. to banks in the same AAA-rated jurisdictions and similar assets as before.
The “problem” would thus remain unsolved. Unless Africa develops more highly secure savings instruments through the coordination of sound macroeconomic governance and financial sector development, the tendency for prudent managers to choose financial instruments minted elsewhere will remain.
Ghana, for example, burned through 60% of its reserves very quickly as its recent fiscal crisis deepened in 2022.
It is not only African countries that keep a lot of their reserves abroad. Except for 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 foreign exchange reserves through Merrill Lynch and Bloomberg Barclays Capital index-linked funds in North American and European bonds and notes.
The Bank of Israel’s core benchmark portfolio also consists of US and European bonds, with yields falling to near zero over long periods of time – Israel’s foreign exchange holdings are about 70% of Africa as a whole. More than 80% of Colombia’s foreign exchange reserves are inside US Treasury bonds and notes.
Holding foreign currency assets
Turkey’s foreign exchange reserve policy exhibits similar conservatism. The dominance of the reserve currency means that even a rich and stable country like Switzerland, which holds reserves equivalent to 91% of GDP, ends up holding most of them in foreign investment vehicles.
Since the usual point of foreign exchange reserves is to hold foreign currency assets, if the objective is to have the means to to strengthen the value of the local currency when necessary or to support trade when local traders cannot access enough forex from local banks, the Ghanaian President’s complaint about low returns somehow misses the point.
These returns correspond 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 to, say, Ghana or Nigeria in the hope of earning cedi or naira returns is simply inappropriate. Indeed, highly restrictive investment mandates are the hallmarks of central bank foreign reserve portfolio design.
Governments in Africa often need to hold forex reserves because compared to the emerging market average of 11% of GDP, the African private sector’s foreign currency asset position is around 3% of GDP.
For longer-term “national savings,” such as holdings in sovereign wealth funds, the dynamics are somewhat different, though surprisingly similar in important respects.
There are indeed African sovereign wealth funds that hold most investments locally. Ethiopia is one, but that’s mostly because the investments (not “reserves”) are mostly in the form of stakes in state-owned companies. Ghana is one of those countries that permanently prohibits some of its state vehicles from investing locally.
Repatriating dollars to, say, Ghana or Nigeria in the hope of earning cedi or naira returns is simply inappropriate.
Even with sovereign wealth funds and other subsets of sovereign wealth vehicles, there could be legitimate reasons for investing mainly abroad, for risk management purposes. One such reason is proactive ‘diversification’. By spreading investments across overseas jurisdictions, uncorrelated returns are ensured during times when certain markets (including the home country) are in crisis.
Singapore, for example, invests 74% of its sovereign wealth funds abroad. It also does so because, in the course of their research, funds may identify highly profitable sectors that are simply better developed elsewhere than domestically.
For similar reasons, only 9% of Middle East sovereign wealth is invested domestically: Europe, Australia and North America take a combined share of ~62%. Furthermore, in the same line of analysis, many sovereign wealth funds are established to unlock more foreign investment.
Foreign investors
Building relationships with foreign investors sometimes requires co-investing in various opportunities. Such co-investments are more likely to initially target international prospects. This has been the experience of Gulf and Middle Eastern sovereign wealth funds, which today own everything from football clubs to registration rights for individual athletes in Europe and America.
If the main objective is to ensure asset safety and avoid dispersion, as in the case of Ghana’s oil capital, the lack of local ultra-low-risk assets will hinder the goal of intergenerational national wealth investment at the local level , especially in the wake of domestic debt defaults.
On closer examination, the call for reserve-repatriation sounds less obviously brilliant than at first. It certainly needs a lot more technical discussion, something it has yet to benefit from. The Ghanaian government has not even started a proper political dialogue in their country. A position paper, at least, would be nice.
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