Africa’s Currency Speculation Fight Heats

Suppose a central bank is incapable, or unwilling, to meet all the demand for foreign exchange at its official exchange rate and seeks to protect or provide a temporary stopgap for its foreign exchange reserves during unpalatable balance of payment adjustments. In that case, it often implements foreign exchange controls. Unfortunately, these restrictions typically encourage evasion and do not address the fundamental economic policy weaknesses that lie at the root of the chronic balance of payments difficulties. As a result, quantitative controls on the availability of foreign exchange through official windows get the ball rolling for black markets in foreign exchange to develop because those who need foreign exchange will be willing to pay a premium on the official rate to obtain it. 

The size of any black market in foreign exchange and the exchange rate premium it commands over the official market largely depends on the tightness of controls applied. Where the central bank meets most of the prevailing foreign exchange demand, the black market is smaller than the official market, and the black-market exchange rate is volatile. On the flip side, countries facing chronic balance of payments pressures and having insufficient reserves or borrowing capacity to defend the official rate will typically have well-developed and organized black market structures, with foreign exchange sometimes trading at ten times the official rate.

In emerging markets and some developing economies, the pervasive foreign currency shortages and exchange rigidities lead black-market production structures to operate in tandem with the official markets for foreign currencies. These black-market rates often bear little resemblance to the actual market conditions. A history of high levels of inflation that caused people to lose their capital and savings continues to fuel the loss of confidence in local currencies and bolster the popularity of the dollar and other stronger currencies. 

Policymakers are Fighting Tooth and Nail…

But policymakers generally give black markets a hard pass because they divert scarce foreign exchange from official windows to uses that the controls are trying to limit. Zambia, for instance, arraigned a few persons in court in May for illegally dealing in forex for five years. This is part of the government’s wider effort to rid the street of black-market money changers to thwart speculative activities contributing to the devaluation of the local currency. On the other hand, South Sudan is adopting a more accommodative approach that may give it a stronger oversight of its foreign currency black market as the initial clampdown measures fell like a pack of cards. The Bank of South Sudan (BoSS) has asked parallel market traders to form umbrella associations or organize themselves into structured groups, operate in permanent structures from designated locations, and register as dealers with the central bank while paying taxes to the government. 

Africa’s policymakers are not alone in their wing-clipping efforts against unauthorized currency dealers. For instance, North Korea is talking tough to private money changers, who risk having their foreign and domestic accounts confiscated if they exchange the greenback at a rate significantly higher than the official market. Also in Lebanon, street foreign currency traders were arrested, and their shops sealed, as security forces raided homes and centers where money-exchange activities normally take place. 

…But No Dice with Fighting Dirty

In my opinion, the monetary authorities may have lost the plot by embarking on a futile exercise of clamping down unauthorized dealers. A currency garners strength through exports, not by criminalizing and jailing people who want to earn a living; neither does this approach restore confidence in the local currency. Outlawing street traders is not the most effective approach to stabilizing the local currencies because it does not address the fundamental issue of lack of confidence in the local currencies. Besides, many of these traders do not quit the trade but go underground and devise more creative means to continue their business. 

Also, many of these markets have some restrictions on access to foreign currency. In Nigeria, for instance, restrictions are still in place on most Naira ATM cards as they cannot be used to pay for dollar transactions. Also, the Zimbabwean government is refusing its own money for some of its services, such as passports and fuels, as it has allowed gas stations to decline the local currency for the US dollar. How do you want to coerce private individuals and businesses into accepting the local currency you print when you reject it as payment for goods and services you provide?

So, rather than focusing on foreign exchange demand or supply crackdowns, state actors should work towards liberalizing the market and allowing the exchange rate to settle at market-determined rates. A higher market-determined exchange rate will mean people and businesses will cut back on their demand for dollar-denominated goods and services and will have the option of going through the official windows to meet these demands.

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https://squareafrica.org/africas-currency-speculation-fight-heats/