Thursday, June 01, 2023

On Forex Mismatch

I want to share my thoughts on the article “Forex mismatch widens year after devaluation” published on the Nation website on 30th May 2023.

The article reports that there is a huge gap of K514 between the official exchange rate of the kwacha and the bank rate, especially the cash rate. I would like to suggest that this gap cannot be solved by devaluation because it is not caused by demand but by the costs and profits for the banks and parallel market forex traders. This is what one of them told me when I asked about the reason for the gap. Our policymakers need to understand this, otherwise, they will keep devaluing the kwacha but never achieve a narrow gap.

When economists see that demand is high, they usually increase the commodity's price. In the case of currencies, increasing the price means devaluing the currency.

But let's compare this to goods in a wholesale and retail setting. When the wholesale price goes up, the retail price also goes up because the retailer wants to keep his profit margin and cover his costs.

In the case of forex trade, the Reserve Bank rate is like the wholesale price and the bank rate is like the retail price. The gap, which is due to costs and profits, cannot be reduced by devaluing the currency more. If the Reserve Bank wants to reduce this gap, it has to limit the profit margin that the banks and parallel market can make from forex trade.

So, in my opinion, the gap of K514 mentioned in the article can be reduced not by further devaluation, but by regulating the profit margin of the banks and parallel market.

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