Developing countries face a triple challenge of managing a stronger US dollar, China’s economic slowdown and a significantly weaker oil price.

China’s economic transition brings uncertainty. And yet its financial liberalisation is likely to result in continued outward foreign direct investment and trade with its trading partners from 2014 levels. Meanwhile, lower oil prices and an appreciating US dollar will be harmful to some sub-Saharan African economies in the form of further inflationary depreciations, higher debt and deteriorating reserve positions.

China’s balancing act

China faces a difficult balancing act. This entails deleveraging, slower growth and capital account liberalisation. Alongside the country’s deleveraging, it is expected by the Organisation for Economic Co-operation and Development to grow at 6.5% in 2016, less than half of its 14% growth before the 2008 global financial crisis. All the while, it is liberalising its financial system. The impact of this balancing – of deleveraging, slower growth and financial liberalisation – will be mixed.

Oil prices: a new (and lower) normal

Following a 50% decline between mid-2014 and mid-2015, the West Texas Intermediate measure of oil prices currently hovers around $40 a barrel. Lower energy demand in the US and, in the short term, in China is a structural driver of the decline. SSA oil exporters’ terms-of-trade (TOT) will be a particular source of vulnerability for economies with declining reserves. Our matrix of impacts suggests that, although most SSA economies see benefit from lower oil prices – including some oil producers, such as Ghana – others, such as Democratic Republic of China (DRC) and Nigeria, look vulnerable.

This oil price shock is important to consider: it has triggered corporate profitability concerns, it has been largely unresponsive to Organization of the Petroleum Exporting Countries production freezes and it has been driven by a structural demand shock. The outlook for oil prices is subdued particularly given that the US is now largely energy self-sufficient as domestic shale production drives down US energy imports. China’s energy demand is a source of debate, although its long-term demand to 2035 is expected to be robust given its infrastructure spending plans.

The US dollar’s momentum

The US dollar has appreciated by 28% from its July 2011 trough. This has been in part because of expectations of the Federal Open Market Committee (FOMC) tightening policy, a process which it indicated in May 2013 that it would start to contemplate. This will boost the US dollar given easing measures in Japan and the Eurozone. Although expectations have been scaled back, further dollar strength is also expected in 2016 given investor demand for US safe haven assets amid global financial volatility.

Widespread SSA currency depreciation, particularly against the US dollar, has led to tighter monetary policy, or engineered currency strength in SSA, to counter inflationary pressure. In Nigeria’s case, the naira-managed peg has been used to contain inflation risk. DRC uses dollarisation. This is necessary: currency depreciations that surpass 10–20% could trigger exchange rate pass-through inflation effects as large as 18–25% percent.

SSA investment outflows are most likely from economies with ‘twin’ deficits in their current and fiscal accounts. FDI inflows have been positive, although DRC, Nigeria and Uganda have been outliers. Portfolio flows have remained solid in Kenya, Nigeria and Zambia, although bond inflows have dropped dramatically in Ghana, Nigeria and Zambia. Global financial volatility could limit capital flows to SSA and restrict access to finance, particularly for economies with rising debt levels.

Vulnerable SSA economies

A number of SSA economies have been subject to multiple shocks. In Nigeria, the impact of lower oil prices has been felt, in part, through a decline in inward FDI. Further capital outflows will exacerbate its deteriorating debt and reserve positions. Nigeria’s sharply weaker external position, and falling reserves, suggest the naira peg will continue to come under pressure, with further devaluation likely.

Developments in Ghana’s economy suggest it has not yet borne the full brunt of lower oil prices. The impact of a strong dollar and higher US interest rates has been felt. At 26%, its policy interest rate is at a record high and aimed largely at countering the inflationary impact of cedi depreciation. Ghana’s high level of dollar-denominated debt and low level of reserves make the macroeconomic outlook vulnerable, with debt distress likely.

In DRC, despite expectations of resilient GDP growth, the economy faces multiple sources of instability from its TOT deterioration and the low level of reserves. The weakening in its current account is likely to exacerbate its net foreign asset position significantly. A slowdown in commodity prices and in China’s demand is a key source of vulnerability too, given that 94% of fuel exports go to China. This makes DRC’s overall GDP growth particularly sensitive to China’s economic growth.

SSA governments should upgrade their currency policies

There are three policy areas that could enhance SSA central banks’ ability to counter financial shocks. Greater alignment of market rates with the policy rate would increase the effectiveness of each rate move, which for SSA central banks would mitigate further rate rises from already prohibitively high levels. Second, helping SSA countries control capital flows that fuel boombust cycles matters. Finally, more robust liquidity forecasting would help SSA central banks protect their reserve positions, particularly those with weak exchange rates and a loss of oil revenues.

Improving global economic governance

Although everyone has paid lip service to better governance as an effective means of protecting against shocks, it is an undersupplied public good. New types of global institutional collaboration, information exchange and liquidity arrangements are needed. Inclusion of private financial institutional investors, through formation of an Investor (I) 20, in addition to the other G20 groups, would facilitate improved institutional collaboration and information exchange. It would enhance the monitoring and transparency of high-frequency trading in financial markets. This is important given that financial crises are rarely like their predecessors. Finally, enhanced regional contingency reserve arrangements targeted to SSA would bolster liquidity and provide some counterbalance to the US Federal Reserve.

Key messages from this report are:

• Developing countries will need to manage a stronger US dollar, economic slowdown in China and a significantly weaker oil price.

• The joint impact of this triple dynamic is important now given some developing economies’ inability to counter these shocks.

• Most sub-Saharan African economies will benefit from a lower oil price; yet oil exporters’ declining reserves, is a key vulnerability.

• US dollar strength risks fuelling further Sub-Saharan African inflationary depreciations and macroeconomic instability.

• Nigeria and Democratic Republic of Congo have seen deteriorating external accounts whereas Ghana’s debt looks unsustainable.

• On the policy front, domestic monetary stabilisation needs to be accompanied by improved global economic governance.