MALAWI'S FOREIGN EXCHANGE RESERVES ALMOST ON EMPTY, IMF TO

UNCLAS SECTION 01 OF 02 LILONGWE 000700 SENSITIVE SIPDIS LONDON FOR AFRICA WATCHER PETER LORD E.O. 12958: N/A TAGS: ECON EFIN ETRD MI SUBJECT: MALAWI'S FOREIGN EXCHANGE RESERVES ALMOST ON EMPTY, IMF TO HELP REF: LILONGWE 574 and previous LILONGWE 00000700 001.4 OF 002 ¶1. SUMMARY: Malawi's foreign exchange reserves currently stand at less than two months' import cover. The Reserve Bank of Malawi (RBM) has been forced to ration its limited foreign exchange allocations to commercial banks. The situation is affecting the country's importers who are unable to get the foreign exchange they need to complete transactions. Malawi's tobacco-dominated exports reached a record level in 2008, but higher global prices for petroleum and fertilizer have exhausted the supply quickly. A recently approved IMF facility should ease the pain as early as this month. Comment: The GOM's managed exchange rate is forcing commercial banks to sell U.S. dollars at a twenty percent discount below the rates charged by private exchange bureaus. This continues to put pressure on reserves and push more of the Malawi's limited foreign exchange away from the banks, the only institutions authorized to facilitate international transactions. End Summary. Unusually Scarce FOREX Squeezes Economy -------------- ¶2. For the first time since President Mutharika began to implement macroeconomic reforms, Malawi's foreign exchange reserves declined to below two months of import cover at the end of October 2008. Several companies who rely on imports to operate have complained that the Reserve Bank of Malawi (RBM) is severely rationing allocation of foreign exchange to the commercial banks. The RBM admitted to emboff that the foreign exchange situation was serious and it was forced to ration its limited supply. Companies have reported that suppliers of imported raw materials have threatened to stop shipments due to non-payment for previous orders. Some companies have complained that they have been forced to put customers on long wait-lists for deliveries, and have already lost business as a result. ¶3. Traditionally, foreign exchange availability follows the agricultural cycle in Malawi. It is plentiful from April through September (tobacco selling season),and scarce from November through March. During periods of scarcity, importers/investors may experience extended periods without access to foreign exchange. The significance of the current shortage is in its timing (very early) and magnitude (very severe). At the end of October, foreign exchange reserves declined to 1.8 months of import cover and the situation is feared to get even worse before next April's tobacco harvest eases the situation. Surging Import Bill Outpaces Record Tobacco Earnings -------------- -------------- ¶4. Malawi's import bill averages about US $140 million per month and primarily consists of petroleum products, agricultural inputs (fertilizers, equipment and chemicals),motor vehicles, industrial equipment and almost all manufactured products. In turn, Malawi's exports are primarily agricultural, with tobacco accounting for more than half of total export earnings. Despite record tobacco sales in 2008, the global rise in fertilizer and petroleum prices has quickly exhausted this source of foreign exchange. (Finance Minister Gondwe told the Ambassador ruefully that Malawi had bought forward contracts on fuel that had locked in prices at their peak.) The remaining sources of foreign exchange are foreign project financing, donor support to the budget and balance of payments, and correspondent banks lines of credit. ¶5. According to RBM, there are a couple of explanations for the shortage. Current turbulence in the global financial/capital markets has drastically reduced trust and confidence among correspondent banks, affecting availability of credit lines and investment in each other's banks. Secondly, the Malawi import-dependent economy is growing faster than its export sector, thereby widening its trade deficit and creating a bigger gap between demand and supply of foreign exchange. Many development projects, such as the construction of roads and buildings, require imported materials. Moreover, Malawi's imported goods sector has grown remarkably during the past few years. The growth has been fueled by new GOM financial policies that have caused banks to move away from investing in treasury bills to private sector lending. Small personal business loans have more than doubled since 2005 and most of these loans are to open trading businesses, buy cars, and or build houses. Little has been invested in forex-generating businesses or agricultural production. ¶6. The foreign exchange situation is unlikely to improve significantly in Malawi until the start of the tobacco selling season in mid-March. Meanwhile the RBM is relying on the small export earnings it receives primarily from non-agricultural sources. LILONGWE 00000700 002.4 OF 002 IMF Agreement Eases Pressure -------------- ¶7. The Malawi government has just concluded with the IMF for an "Exogenous Shock Facility" that will help get the GOM through to tobacco season. The ESF is a one-year facility that will make roughly USD 77 million available in front-loaded disbursements (about USD 50 million will be disbursed in December). ¶8. Comment: While the RBM will not admit it, a managed foreign exchange rate policy is part of the problem. President Mutharika vowed during his inauguration speech in 2004 that there would be no depreciation of the Malawian kwacha during his tenure of office and he has been true to his word. Financial institutions must adhere to rates within a set band linked to the U.S. dollar or risk decreased foreign exchange allocations from the RBM. However, this policy does not apply to private foreign exchange bureaus. There is currently a spread between commercial banks' rates and exchange bureaus of over twenty percent. The spread is further driving the limited supply of foreign exchange in the country away from the banks, which have sole legal authority to facilitate international transactions, to a growing financial gray market. End Comment. BODDE