US embassy cable - 05LILONGWE283

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, Economic 
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