MALAWI KWACHA UNDER SPECULATIVE PRESSURE

UNCLAS SECTION 01 OF 02 LILONGWE 000283

SIPDIS

SENSITIVE

STATE FOR AF/S ADRIENNE GALANEK
STATE FOR EB/IFD/OMA FRANCES CHISHOLM
STATE FOR EB/IFD/ODF LINDA SPECHT
TREASURY FOR INTERNATIONAL AFFAIRS/AFRICA/LUKAS KOHLER

E.O. 12958: N/A
TAGS: EFIN EINV ECON MI BUD FIN
SUBJECT: MALAWI KWACHA UNDER SPECULATIVE PRESSURE

REF:

This message is sensitive but unclassified--not for Internet
distribution.

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SUMMARY
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1. (U) Malawi's banks are reporting a surge in demand for
foreign currency. Experts attribute the surge to
speculation that the GOM may devalue the currency as the
tobacco auction starts on March 29 or shortly afterward.
The governor of the central bank has given no clear signals,
though it appears the bank has adequate cover to maintain
the Kwacha until import revenues begin to flow. End summary.


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HIGHER DEMAND, THIN RESERVES
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2. (SBU) Over the past several weeks, commercial banks here
have tightened their restrictions on foreign currency in the
face of noticeably higher demand. Industry analysts report
that some customers expect a devaluation of the Kwacha as
the tobacco auction floors open on March 29. Such a move
would be popular, as it would effectively remove the black-
market premium farmers are paying for an artificially high
Kwacha. (The parallel rate for the Kwacha has climbed in
recent months from about MK116/USD to as high as MK125/USD,
while the official rate has stayed at about MK110/USD.) The
speculation has spurred higher demand for foreign currency
as importers and holders of foreign currency denominated
loans rush to pay early.


3. (SBU) Both official and commercial reserves are thin, at
about 1.4 months of coverage (at historically average levels
of demand),but are likely adequate to maintain the Kwacha
over the next few weeks. This level of forex reserve is far
below the target 3 months, but slightly above the 1.3-month
average since December 2004. Foreign exchange availability
is highly seasonal in Malawi, flowing freely April to
September, when tobacco markets are open, and drying up
October through March. During the periods of scarcity,
importers and other forex users usually do not have
immediate access to foreign currency.


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TOO CLOSE FOR COMFORT?
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4. (SBU) Up to now, the Reserve Bank of Malawi (RBM) has
provided no signals to the market. The new governor has
told us he would like the currency to float more freely, but
few observers believe he will defy President Mutharika's
public promise not to devalue the Kwacha. (Interestingly,
the governor did not have an agreement on this question
before he accepted the job.) At this point, it is difficult
to say where the threshold of discomfort lies, and how few
reserves--or how vigorous an attack--would trigger a
devaluation. For the moment, anything near 1.5 months of
coverage each for official and commercial reserves seems
comfortable enough.


5. (SBU) On the other hand, several factors point to a
possible devaluation. The RBM recently announced that it
will no longer buy dollars on the tobacco auction floor,
which removes a major lever it has used against speculative
behavior on the part of commercial banks. Without direct
(forced) access to foreign currency, the RBM must now depend
on the banks' good behavior. Secondly, pressure is mounting
from high global petroleum prices, from which the GOM has
been (unsustainably) shielding its consumers. Finally, the
black market premium on the Kwacha is causing exporters to
complain ever more loudly that they cannot maintain export
volumes at an artificially low rate of return.

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COMMENT
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6. (SBU) The RBM is caught in a difficult position, with
mounting pressure to devalue but equal or greater fiscal
pressure to hold on at least until the International
Monetary Fund has put a new funded program in place. The
IMF's decision has been delayed because of the possible
budgetary impact of emergency food imports, which means new
donor inflows are unlikely before August. Add to that a
lean budget and a low IMF ceiling on inflation, and the
incentive to hold on is clear. But with the prospect of
tobacco earnings for the next several months, followed
quickly by new donor money, the RBM is clearly tempted to
release a little pressure now, while the release may still
be controllable.

GILMOUR