ON THE KWACHA!

One of the ways of dealing with the current depreciation of the kwacha is what is called monetary shock therapy. In this method, you are trying to kill the speculators because they can really do some damage when left to their own devices. The central bank can do this in a day or a week but basically it involves getting in the market with full force. The central bank always conducts open market operations (selling of dollar, buying kwacha or vice versa) depending on which currency they are trying to stabilise. In case of the current circumstances, the aim is to stabilise the kwacha so they will be buying kwacha on the market using the dollar. 

In a monetary shock, the central bank makes a calculated risk by getting in the market with full force with an added element of surprise mostly. In Zambia's case, we can define only half a billion dollar day position has full force. It can be much more for other countries depending on the GDP. When word gets out that the central bank is in the market with half a billion dollar bazooka,financial market players will get agitated. Remember, in Forex dealing, even 0.5 is a very big thing, if you have $10,000,000 position and the rate dips just by 0.5, you lose K5, 000,000. So with such news, there is a race to the exist door with financial players all avoiding the storm that is about to hit them. Let me give a street example to drive the point home. The current onion prices brought some speculative activity with part of the price not justified whatsoever. Now imagine what would happen to traders at Soweto who go home to sleep with a price of 10kg at K150 and in the morning, they find 100 trucks of onion from SA waiting to offload. There would be panic and price might tumble by even 50% in a day. That is the same setup with the currency shock therapy. Shock or rattle the market participants and make them bleed on their way to the exist door. The central bank is sending a message that speculative behaviour will not be tolerated.

But currency shock therapy is difficult to pull off because financial players invest alot in information. They are street smart and not so gullible like voters because there is alot on the line. It's a high stakes game that you don't leave to chance. If for example BOZ tried to pull off a move like this, financial players would simply call it bluff because they know BOZ only has $1.2 billion in reserves,to get half of that and start fighting a currency slide is suicide. Financial players will know that BOZ doesn't have enough muscle to last 5 seconds in the ring. So the kwacha might gain abit for two hours or so due to initial panic but again start losing because players have seen the bluff and won't fall for it. It might actually fall by more than the initial rate because players will factor in the fact that BOZ has just thrown half a billion dollar in a black hole and is now weaker.

But it becomes a different matter altogether if BOZ had $10 billion in reserves for example or if the country has just clinched the IMF deal. In this case, chances of success are very likely. Players will know that the central bank has a massive war chest and are out for blood. 

Hank Paulson, the former US Secretary of Treasury summed it up nicely when he said," when you have a bazooka and the market knows that you have one, you may not even need to use it". "But if you dont have a bazooka and the market knows it, then you can sing on top of your voice that you have one but the market will simply laugh at you and call it bluff"!

Do you get the drift?

Needless to say, speculation is not the cause of the current currency slide ,its just a consequence which is aggravating the problem further.