US embassy cable - 04LILONGWE842

C O N F I D E N T I A L SECTION 01 OF 02 LILONGWE 000842 
 
SIPDIS 
 
STATE FOR AF/S TED CRAIG 
STATE FOR EB/IFD/OMA FRANCES CHISHOLM 
STATE FOR EB/IFD/ODF MARLENE BREEN 
TREASURY FOR INTERNATIONAL AFFAIRS / AFRICA LUKAS KOHLER 
 
E.O. 12958: DECL: 08/26/2014 
TAGS: EFIN, ECON, MI, Economic 
SUBJECT: MALAWI'S CENTRAL BANK FIGHTS TO MAINTAIN KWACHA 
 
 
Classified By: Econoff William R. Taliaferro for reasons 1.5 b and d 
 
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SUMMARY 
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1. (U) With the Malawian kwacha under increasing pressure, 
the Reserve Bank of Malawi (RBM) has so far managed to 
maintain its value by using a combination of methods, 
conventional and otherwise.  A small, heavily invested market 
with few speculative options has helped them up to now.  In 
the long run, RBM's tricks cannot substitute for a solid 
fiscal policy.  End summary. 
 
 
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CONVENTIONAL TOOLS: MORAL SUASION AND CAPITAL CONTROLS 
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2. (U) The Reserve Bank of Malawi describes its efforts to 
maintain the kwacha's value as a combination of intervention 
in the market and "moral suasion," made the more effective by 
a lack of attractive investment alternatives to treasury 
bills.  This seems to be borne out by the continuance of 
fully subscribed T-bill auctions despite sharply lower 
interest rates and a higher volume of issuances over the past 
several months (though real rates, at about 15 percent, are 
still high).  Given most financial institutions' already 
heavy stake in government paper, there is some incentive to 
keep buying simply in the fact that new issuances are largely 
financing current maturities.  Senior executives at the bank 
acknowledge that traditional tools, including higher 
liquidity reserve requirements (currently 27.5 percent) and a 
controlled capital account, are helping to keep speculative 
pressures down despite high liquidity and low foreign 
exchange reserves (1.5 months, against a normal seasonal 
reserve of 2.5 to 3 months). 
 
 
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NOT-SO-MORAL SUASION WORKS, TOO 
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3. (C) Outside the bank, we have heard that the RBM is using 
other, less ethical tools as well.  The state-controlled 
tobacco auction is the main source of dollars in the economy. 
The bank has said that it is buying dollars from the auction 
floor to ensure timely transaction times and a consistent 
exchange rate, and is benefitting more or less incidentally 
from controlling the dollars.  According to a senior 
executive at the National Bank of Malawi, RBM is requiring 
the auctioneer to clear all dollar sales through the RBM, 
except for those deposited directly to dollar denominated 
accounts.  This gives RBM a monopoly on about half of the 
dollars flowing through the floor, to the (possibly illegal) 
exclusion of commercial banks. 
 
4. (C) The other instrument takes more direct aim at 
controlling speculation in the commercial banks.  According 
to a discount house executive, the RBM has threatened not to 
sell currency to banks if they do not observe an unofficial 
floor on the kwacha's value against the dollar (currently 
said to be MK110/dollar).  This measure has allegedly been 
used in the past on Stanbic Bank, at a measurable cost in 
market share. 
 
 
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COMMENT: IN THE LONG RUN, IT'S ABOUT RESPONSIBILITY 
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5. (C) Nearly every informed observer of the kwacha 
characterizes its position as precarious.  The RBM has 
succeeded up to now in defending its currency, despite thin 
reserves and, until June, increasingly inflationary spending 
by government.  The bank is quick to say the market here is 
so small that normal market dynamics (according to which a 
lowering of rates would lessen demand) do not apply.  This is 
their logic for arguing against the IMF's demands for higher 
bank rates: since rate changes seem not to affect demand for 
government paper, the GOM should pay as little as the market 
will bear.  To the extent that RBM can squelch other 
investment opportunities, and they evidently can, the 
situation will probably stay contained for the time being. 
In the longer run, though, the bank's machinations have to be 
backed by a responsible fiscal policy.  So far, the Mutharika 
government appears to be cognizant of the danger and 
determined to avoid it. 
 
RASPOLIC