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