Where international finance meets development: The role of currency risk

This is the fourth blog focusing on the role of currency risk for development in a series highlighting five priority areas for financial inclusion in Africa. See the third post here. 

Economists have long studied how currency swings caused by changes in exchange rates influence economies and investment. But these ideas rarely make their way into the everyday questions that matter in development: how businesses grow, how entrepreneurs find financing, or why some firms scale while others do not. Often international finance is treated as something happening in the background rather than a force that directly shapes who gets access to capital.

A big reason for this gap is that currency movements and financial markets are hard to study with development-related rigorous micro tools. One cannot randomly assign an exchange‑rate shock, for example. That makes careful and creative empirical work, such as using firm‑level data, administrative records, or quasi‑experimental designs, especially important for understanding how central these dynamics are and how enormous the potential impact on questions in development economics might actually be.

Some recent studies have begun to move in this direction, showing how global financial mechanisms influence firm outcomes in African markets (e.g., see here, here, and here). But much remains to be understood and several key research questions stand out. In this post, we’ll dive into why this is important and what open questions we see on the horizon.

Why foreign exchange risk and local capital deserve a central place in development debates

In many African countries, the way money moves within the country and across borders has an impact on people’s lives and plays an important role in shaping development outcomes. Exchange‑rate risk, or the uncertainty created by changes in the value of a country’s currency, is embedded in international finance through everyday cross‑border activities such as loans, investments, trade, and remittances. This has an effect on economic activity.

When exchange rates swing, it becomes harder for local businesses to plan ahead. Sudden depreciation of local currency can make it more expensive to repay loans taken out in foreign currency, and limited access to financing in local currency also affects the choices businesses make: whether they can hire new workers, invest in equipment, set prices, or grow. 

Countries usually face a choice about how to set their exchange rates, which is commonly discussed as a trade‑off between stability and autonomy. Pegging a local currency, typically to the US$, can help keep prices stable and predictable, while a more flexible approach allows for quicker responses to unexpected events and maintains monetary independence. Both options come with trade-offs, and there is no one-size‑fits‑all solution.

Our conversations in Nairobi last year highlighted an important perspective: Currency movements also shape how risk is distributed across governments, firms, households, and investors. When exchange rates move, someone must absorb the losses, and this allocation shapes which financial contracts make sense and who gains access to capital in the first place.

In countries where financial markets are small and offer few ways for firms and investors to protect themselves from currency swings, foreign exchange (FX) risk does not disappear. Instead, it shows up in higher interest rates, is built into firms’ and investors’ balance sheets, or leads investors to walk away altogether. In this way, currency risk influences development not only by affecting inflation or stability, but by shaping who can borrow and grow.

Understanding better how these dynamics affect development economics matters, because it can influence the debates about entrepreneurship, firm growth, and private investment in African countries. 

How currency risk shapes households, firms, and markets

Remittances provide an example of how currency risk affects everyday economic activity. For many households, remittances are a key source of income and insurance. But sending money across borders requires dealing with foreign currency. When exchange-rate volatility rises or FX markets become illiquid or difficult to trade in, money transfer operators face higher costs that are difficult to hedge in the short run. These costs usually end up on the consumer’s side in the form of worse exchange rates. 

In our meeting in Nairobi with NALA, an international money transfer platform, this friction was especially clear. The company emphasized that it does not hedge currency risk and, in countries where the gap between official and parallel-market exchange rates is large, it tries to offer rates as close as possible to the parallel rate. At the same time, it avoids entering markets where currencies are too unstable, such as Burundi and Malawi.

The broader lesson is that currency risk is not an abstract concept: It directly affects households by making it more costly to move money across borders. Policies that strengthen FX markets or give providers better tools to manage risk can bring these costs down in ways that competition alone cannot.

The impact of AI, and how it could make currency exchange markets more efficient, was also mentioned in the conversations: For instance, Flourish Ventures has pointed to the use of AI tools that scan markets in real time to secure favorable exchange rates. Similarly, Onafriq, a pan‑African payments provider, applies AI models to anticipate short‑term currency fluctuations during the settlement process (also see our first blog post in this series on how AI is reshaping the access to finance).

Currency risk becomes even more important when firms and foreign investors move capital across borders. When capital crosses borders, shifts in the exchange rate can change the value of investments. When prices differ across countries for long periods, these fluctuations become a source of uncertainty that investors price in. Especially when the global economy slows, currencies in African markets often weaken just as investors are looking for safety, increasing the perceived risk of investing there. 

This connects to a long-standing concern: many African countries cannot borrow on global markets in their own currency, a “challenge often called “original sin”. Because of this, when exchange rates move, the cost of repaying foreign-currency debt can rise quickly, forcing firms and governments to pull back on investment. Currency stability may change how risk appears, but it does not remove it. Firms and investors still feel its effects in ways that matter for growth and development. 

A recurring theme in our meetings with founders, banks, and investors in Nairobi was how hard currency risk becomes to manage when local capital markets are shallow. Firms often face a tough choice: borrow in foreign currency and take on exchange-rate risk, or rely on scarce and expensive local-currency finance.

Local investors matter because they can provide capital in local currency, protecting firms from exchange rate movements. When domestic savings, pension funds, and financial institutions are unable to provide enough local currency, currency risk is priced into interest rates. This raises the cost of borrowing and crowds out exactly the mid-sized firms that are too big for microloans, but too small to access multinational financing. What stands out is that these challenges are visible even in Nairobi, one of Africa’s most dynamic urban economies. If firms in Kenya struggle to secure local‑currency finance, the limitations are likely even sharper in countries with less developed financial systems.

A research agenda hiding in plain sight: from macro frameworks to micro evidence

First, who bears exchange-rate risk?

How is exchange-rate risk allocated across households, firms, and governments under different monetary regimes? Which actors ultimately absorb currency losses when exchange rates move, and how does this affect inequality, firm survival, and investment decisions?

Second, what effect does the availability of local currency have?

When does the presence of local-currency capital meaningfully reduce FX risk for firms? What policies help build domestic markets without crowding out private finance or distorting incentives?

Third, how do institutions and policy affect firm financing under currency risk?

How do exchange-rate regimes, prudential regulation, and development finance institutions shape the types of financing available to firms, including whether credit is offered in local or foreign currency and at what maturity? When do public policies—such as local-currency credit lines, FX hedging facilities, or partial credit guarantees—help relax financing constraints for productive firms, and when do they instead reallocate exchange-rate risk across intermediaries’ balance sheets? Which firms ultimately benefit from these interventions, and do they translate into more investment and firm growth?

Fourth, how can we measure exchange-rate risk at the micro level?

What is the effect of currency volatility on remittances? What are the effects of currency volatility on firm investments, entrepreneurial decisions, investors, etc.? How can FX risk be measured directly at the firm level, —through balance sheets, contracts, pricing, and investment choices, rather than inferred from aggregate volatility alone? Which data sources and empirical strategies best capture how currency risk affects firm behavior over time?

In 2025, J-PAL Finance Sector Co-Chairs Emily Breza and Emanuele Colonnelli convened a group of researchers in Nairobi, Kenya with J-PAL Affiliated Professor Christopher Woodruff and Private Enterprise Development in Low-Income Countries (PEDL) to engage with finance-sector stakeholders and advance the research agenda on inclusive finance for development. These discussions highlighted five priority areas for financial inclusion in Africa, including AI and finance, building venture markets, high-growth entrepreneurship, forex risk and local capital, and agricultural value chains. Building on this, J-PAL’s Finance policy team continues to support new research and synthesizes findings across studies to inform policymakers and financial institutions. Future posts in this series will share evidence-informed approaches to expanding access to financial services, enabling innovation, and building economic empowerment. Subscribe to receive updates.

* We would like to thank all finance-sector stakeholders we were able to meet in Nairobi for their insights and openness: Antler East Africa, Baridi, Beyond Capital Ventures, British International Investments (BII) in Kenya, Central Bank of Kenya, Enza Capital, Equity Bank Kenya, FASA - Financing for Agricultural SMEs in Africa Fund, Fleetsimplify, Flourish Ventures, IETP - Investisseurs et Partenaires, IFC Kenya, Ketha Africa, Kukua, NALA, NCBA Bank Kenya Plc, Norfund, Onafriq, Proparco, Pure Infrastructure Ltd, Qhala, Sayuni Capital, Stanford Seed East Africa, TLCom Capital, TLG Capital, Untapped Global, VestedWorld, ZEP-RE (PTA Reinsurance Company), and 4C Group.