Over the last three years, frontier currencies have taken a notable beating due to the global turbulence of a post COVID-19 recovery and the Russia-Ukraine war. The sizable currency moves have helped contain the recent external pressure, with current account deficits narrowing across the board from their peaks in 2021/22. Nevertheless, we see the foreign exchange (FX) adjustment cycle as far from over and flag four key continued pressure points: i) unfinished current account (CA)  adjustments, with some import controls still lingering; ii) less-than-enough monetary adjustments, with real rates remaining well in negative territory; iii) continued existence of FX backlogs that are yet to be cleared; and iv) global monetary tightening that continues to constrain access to much-needed foreign capital and weighs on local confidence.

Screening frontier currencies

We have devised an FX risk screener, which we use to assess the extent of future risk to currencies under our coverage. The matrix comprises a number of variables, including the strength of FX reserves and their recent direction, real effective exchange rate, real rates, and FX liabilities (including backlogs and gross external financing needs). Our analysis designate Morocco and Vietnam as countries with the lowest FX risk within our coverage and we expect 0-5% depreciation in their local currencies against the USD. They are followed by a second batch (with 5-10% depreciation risk), which includes Bangladesh, Kenya, and Tanzania, whose FX buffers remain, especially when contrasted with still-lingering FX backlogs. Finally, comes the batch with the largest FX risk, which includes Nigeria and Pakistan, in light of unfinished adjustments, relatively still depressed interest rates, and sizable gross external financing needs.