Pressure mounts on the Kwacha

Financial market analysts and economists have said interventions deployed by monetary authorities to contain pressure on the local unit’s are yet to yield fruits as spread of the Malawi Kwacha rate on the parallel market and most authorised dealer banks (ADBs) continues to widen.

But the Reserve Bank of Malawi (RBM) has since faulted speculation for the unit’s volatility.

The Malawi Kwacha is trading at around K1095 per dollar on the parallel market compared to K1800 in most authorised dealer banks (ADBs).

The gap remains highest in recent history which, according to commentators, points to the enhanced pressure emanating from prevailing mismatches in forex demand and supply on the market.

Among other interventions, the central bank devalued the Kwacha by 25 percent in May last year, an act seen as a desperate attempt to realign the exchange rate with economic fundamentals.

At the time, the RBM said imbalances between supply and demand were prevalent in the domestic foreign exchange market, evidenced by low foreign exchange supply, declining official foreign reserves and widening spread of rates on the market.

But since then, the Kwacha has remained largely volatile, losing value against major trading currencies including the dollar.

Recently, the central bank introduced the forex auction system as a price discovery mechanism in the exchange rate market.

The setup was that ADBs would be submitting bids to sell foreign exchange to the central bank at prices or exchange rates freely determined by each participating bank.

During the first auction in June, the market selling price moved to K1063 to a dollar while during the second auction, the market selling price moved up to K1095.

At the second trade in July, the Kwacha fell marginally by 3 percent from K1,063 to the United States dollar to K1,095, the second time in two months that the Kwacha has depreciated after recording a 2.6 percent depreciation in June.

In an interview Tuesday, economist from the Malawi University of Business and Applied Sciences Betchani Tchereni said the auctions were not a solution to the current misalignment.

Tchereni said the auction system was creating panic and anxiety among traders due to instability.

“The biggest solution is that we should be exporting more so that we have enough foreign currency and we should also try to go into organic fertiliser production because we can substitute that with inorganic fertiliser which consumes a lot of foreign exchange in the country,” Tchereni said.

In a separate interview, financial market analyst Bond Mtembezeka said the local unit will remain volatile until the country moves toward addressing imbalances between supply and demand of forex.

“The realigning through auctions is not helping because what is happening is that once an auction is completed, it is signalling to the parallel market to raise the exchange rate cap,” Mtembezeka said.

Financial Market Dealers Association of Malawi President Leslie Fatch said considering the impact a sharp movement in the exchange rate would have on the economic environment, gradual alignments serve better.

He said the key remains ensuring that the process does not yield to unnecessary speculation and panic.

“Price is determined by supply and demand forces. Once the supply side is resolved we should not be seeing such misalignment. Practically though, the fact that the forex market is regulated and the exchange rate regime employed in the country means the rate cannot fully respond to these underlying supply and demand mismatches,” Fatch said.

But RBM spokesperson Mark Lungu insisted that the auctions were the right way of realigning the local unit.

“There is a need to correct the misalignment and we feel the most transparent way is for it to be done through the market,” Lungu said.

RBM Governor Wilson Banda last week told journalists that introduction of the foreign exchange auction market was to remove speculation by discovering the real price of the exchange rate.

“When we bring the auctions and ask commercial banks to drive it, we are looking at what should be the true value of the exchange therefore through the auction we feel that we are getting closer to what the true value of the exchange rate is supposed to be,” Banda said.

The foreign exchange shortage however persists in the country despite a slight improvement in reserves position.

Figures from RBM show that, as of June 30 2023, the country’s gross official foreign exchange reserves increased by 65 percent to $321.53 million from $194.82 million in May 2023.

The import cover for gross official foreign exchange reserves increased by 65 percent to 1.29 months in June 2023 from 0.78 months in May 2023.

The figures also show that preliminary statistics for the second quarter of this year indicated that the merchandise trade balance recorded a larger deficit of $272.0 million than a deficit of $165.5 million reported during the first quarter and compared to a deficit of $252.2 million registered during the same period last year.

The outturn was explained by the combined effect of a 31.8 percent increase in imports bill and a 4.8 percent decrease in exports proceeds.