Bigger problem around dollar shortage

Firms caught stockpiling dollars beyond ‘reasonable’ needs face fines of up to Sh10 million. PHOTO | SHUTTERSTOCK

Last week, NCBA Bank held its economic Forum and managing director John Gachora, who also doubles up as Kenya Bankers Association chair, gave his perspective on the prevailing dollar shortage. Market players should be encouraged to contribute their views on such matters and Mr Gachora makes several arguments.

First, he acknowledges that there is a supply problem but is reluctant to admit a shortage. Mr Gachora says the issue is excess demand for supply to match.

Second, there are no parallel markets, the issue is about the wide spread between the prevailing bank rates and the Central Bank of Kenya’s (CBK) official rate.

Third, opening the interbank FX market will not help the dollar shortage problem.

Let us start with the issue of a parallel market. In March 2020 Central Bank of Kenya released a circular that said it planned to buy $100 million every month between March and June to increase foreign reserves and will purchase a minimum of $1 million from banks at prevailing rates in each deal.

This was strange coming from a regulator because the CBK was sucking out liquidity in the forex market to build its foreign reserves. Now, central banks don’t build reserves by buying in the local market but from foreign earnings like exports, remittances and dollar-denominated loans.

The effect of this exercise became evident just before it ended. Between the end of June and early July, the forex market started experiencing a shortage of the dollar but no one talked about this precipitating problem until November 2020 when Stanbic Bank economist Jibran Qureishi raised the alarm in an investor note that cracks were emerging in the interbank forex market.

Two forex rates were developing in the market, one being the official CBK rate while the other is the actual or executable forex interbank rate and if not addressed will grow into a bigger problem.

Today the problem is much bigger, the interbank has collapsed, and banks are not supplying dollars to the interbank market.

At the same time, banks are quoting a lower screen price to be on the good side of the CBK that averages banks’ screen prices to get its official rate while their rates to customers are much higher creating a widespread between the two rates.

So, the forex market having a widespread and a parallel market is the same thing.

The second is that opening the interbank market will still not solve the problem. If an importer is seeking $100,000 and his bank doesn’t have enough dollars, its treasury department will source more dollars from other banks through the interbank market.

So, the interbank forex market is an efficient one primarily driven by demand and supply where price discovery happens. Banks facing dollar liquidity problems therefore can’t source dollars with the collapse of interbank.

So, the argument that opening the interbank foreign exchange will not help much is surprising. Price discovery in an efficient interbank forex market will help merge the divergence of bank and CBK rates.

Third is the argument that CBK has enough reserves at its disposal just like in previous years and so the problem emerges from increased demand for the dollar. This is similar to arguing that vendors stocking oranges running out of stock is not a shortage in that local market because there are plenty of oranges on the farms.

The fact that CBK has enough reserves is analogous to oranges on the farm. Unless CBK deploys its reserves in the forex market to address the supply gap, the local dollar market remains to have a shortage.

Lastly, Mr Gachora also mentions that there is a need to make it more valuable to hold the shilling vs the dollar. Now, hiking interest rates by CBK won’t be the sharp tool to address that because Kenya’s Eurobonds have yields as high as 14 percent, which doesn’t incentivise those holding the dollar to convert to shillings. As a market player, is he looking at the prospects of devaluation of the shilling?

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