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Overview: A lumpy problem

The state of foreign exchange (FX) liquidity across Africa often shares several key features and challenges that impact the region’s financial markets, in terms of overall stability and functionality.

Many African countries, particularly those classified as lower and lower-middle income countries (LLMICs), have FX markets marked by low, volatile, and “lumpy” liquidity. This means that the availability of foreign exchange can be unpredictable and uneven. For market participants, this is a significant challenge.

Caroline McCreadie
Caroline McCreadie

Director, Cash | Global Network Management

Because of the uncertainty about future foreign exchange flows, market participants often engage in FX hoarding. This further depletes the official foreign exchange market of liquidity, worsening the scarcity and volatility issues.

Central banks in these countries play a crucial role in managing the scarce and volatile liquidity patterns. Central bank intervention in the FX markets intends to stabilise local currency and manage inflation, but this can be hard to achieve because of the structural weaknesses in the markets.

Global banking regulations, such as those imposed by Basel III, have made financing African trade finance less profitable. This affects the availability of short-term dollar liquidity needed for trade finance.

Ghana and Zambia are not immune to these challenges. They are good examples of the real-world impact such issues can have on economic growth and market development.

Ghana and Zambia: Summary

As we reach the mid-point of 2024, Ghana is grappling with debt relief issues that have hurt its financial stability and market confidence.

Discussions with bilateral creditors are ongoing, and there is hope for an agreement soon. Such an agreement could improve the liquidity situation. However, the uncertainty surrounding these negotiations continues to weigh on the market.

Zambia’s financial markets are also experiencing liquidity challenges, heightened by ongoing debt restructuring efforts. The domestic debt market remains the primary source of financing, but funding pressures are increasing. The outstanding stock of government securities has risen, and non-resident investors have withdrawn, thanks to:

  • tighter global financial conditions; and
  • uncertainties around debt restructuring.

This has led to declining demand at bond auctions and rising domestic yields.

Low and volatile liquidity is typical of Zambia's FX market. The scarcity of the US dollar has led to hoarding among market participants, further destabilising Zambia’s currency (the kwacha). The Bank of Zambia has been taking aggressive policy actions, such as adjusting the cash reserve ratio, to recalibrate liquidity and stabilise the kwacha. These measures suggest that Zambia’s FX market requires more active intervention to maintain stability compared to Ghana’s.

Both Ghana and Zambia are facing liquidity constraints in their financial markets, driven by debt-related issues and external economic pressures.

The central banks of both countries are actively involved in managing these challenges, with the aim of stabilising their respective currencies and financial systems.

FX liquidity – the Ghana v Zambia comparison

We can draw some comparisons between the liquidity of Ghana’s and Zambia’s respective FX markets.

Ghana’s appears to have better liquidity than Zambia. Ghana’s local currency, the cedi, is expected to strengthen, and FX liquidity to improve thanks to inflow from cocoa loans. This suggests a more robust and liquid market for Ghana.

In contrast, Zambia’s FX market is characterised by low and volatile liquidity. The kwacha is likely to remain flat against the US dollar due to limited liquidity locally. This indicates a tighter and less liquid FX market.

Zambia’s FX market is also affected by its ongoing debt restructuring efforts, which have led to a withdrawal of non-resident investors from the domestic debt market. This has further contributed to the nation’s liquidity constraints.

Ghana: The role of cocoa loans

Cocoa loans have a marked positive impact on the liquidity of Ghana’s FX market. The inflow of funds from cocoa loans directly increases the availability of foreign currency in the Ghanian market. This improved FX liquidity helps ease pressure on the cedi.

Stabilising effect

The cocoa syndicated loan inflows are expected to contribute to the stability of the cedi in the fourth quarter of 2024. This stability is crucial for maintaining confidence in the currency and attracting further investment.

Substantial FX inflow

Ghana’s cocoa industry regulator, COCOBOD, secures an annual loan to finance cocoa purchases from farmers. For instance, in a recent deal, international banks pledged to lend US$800m for this purpose. This significant inflow of foreign currency boosts the country’s FX reserves.

Central bank support

The Bank of Ghana relies on these FX inflows as an important source of hard currency. This helps the central bank in its efforts to stabilise the cedi.

Seasonal impact

The timing of these loans, typically secured before the new cocoa harvest begins in October, provides a predictable boost to FX liquidity at a crucial time in the agricultural cycle.

Mitigating debt crisis effects

Despite Ghana’s recent debt restructuring affecting investor appeal, the cocoa loans continue to provide a vital source of foreign exchange. This helps maintain some level of liquidity in the FX market, even during challenging economic times.

Spot market opportunities

The higher cocoa prices allow COCOBOD to sell on the spot market, further augmenting its liquidity requirements and potentially increasing FX availability in the market.

Zambia: Future-proofing measures

Mining tax policy

Zambia’s mining tax policy has a remarkable impact on the liquidity in its FX market through several mechanisms.

Dollarisation of mining taxes

Historically, mining companies in Zambia have paid their taxes in US dollars (USD) to the Zambia Revenue Authority (ZRA). The ZRA then converts these USD payments into kwacha with the Bank of Zambia (BOZ).

This process means that the inflow of USD from mining taxes only impacts the FX market when the BOZ actively sells its dollars. This lag can create periods of low liquidity in the FX market, as the timing and volume of USD sales by the BOZ are not always aligned with market demand.

‘Hoarding behaviour’

The scarcity of USD in the market, partly due to the way mining taxes are handled, leads to hoarding behaviour among market participants. This exacerbates the liquidity issues, as participants are reluctant to convert their dollars into kwacha and so contribute to further depreciation of the local currency. This cycle of hoarding and scarcity perpetuates instability in the FX market.

Time for a change?

There have been calls to revisit the mining tax policy to reintroduce more USD liquidity into the FX market. By allowing mining companies to sell their USD earnings directly into the market to fulfil their local currency obligations, the flow of USD could be more consistent and responsive to market needs. This change could help stabilise the kwacha exchange rate by ensuring a more regular supply of foreign currency.

These calls come on the back of a significant increase in dollar deposits within the banking sector, driven by concerns over currency depreciation and strategic financial decisions by individuals and corporations.

Other proposed policy and regulatory revisions

Zambia has also considered revising lending regulations to allow local banks to engage in short-term lending transactions in the local currency with international counterparts. This move is intended to bolster liquidity in the FX market and reduce pricing discrepancies between domestic and offshore markets.

The BOZ is contemplating the use of International Swaps and Derivatives Association (ISDA) documentation to standardise trading relations and bolster the money market. This step aims to streamline trading relations, facilitate the extension of credit lines, and provide stability and depth to the FX market.

Furthermore, the BOZ is exploring the introduction of blockchain-based smart contracts to automate and standardise FX transactions. These contracts offer transparency and security, potentially enhancing market efficiency.

Impact on market sentiment

The current system, in which the BOZ controls the release of USD into the market, often falls short of meeting demand, leading to persistent USD scarcity. This persistent scarcity undermines confidence in the kwacha and contributes to its volatility due to the limited economic diversification, which makes Zambia reliant on imports and vulnerable to external shocks.

Adopting a more transparent and market-responsive approach to handling mining tax revenues could improve market sentiment and reduce volatility. To strengthen Zambia's financial system, key measures can be taken in several areas, including:

  • strengthening the financial sector;
  • improving the FX market;
  • promoting financial inclusion;
  • developing the bond market;
  • enhancing payment systems;
  • attracting foreign investment; and
  • maintaining macroeconomic stability.

The BOZ has raised its key interest rate by 100 basis points to 13.5% to counter foreign exchange risks and stabilise the kwacha. This measure is part of a broader strategy to address tight liquidity and currency volatility.

Stimulus measures

The Zambian government has also implemented stimulus packages to liquidate a portion of its outstanding arrears to suppliers and contractors, including oil marketing companies. These measures are intended to inject liquidity into the market, but their effectiveness is limited by the broader structural issues in the FX market.

In a nutshell…

While Ghana expects improvements in FX liquidity, Zambia is grappling with low and volatile liquidity, requiring more active management and intervention from its central bank. Zambia has plenty of options on the table, but none will be effective unless they are implemented.


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