Strengthening Zambia's FX Market Structure for Kwacha Stability - An In-depth Advisory Essay

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Sincere gratitude to Lukwesa Munyinda for his generous and substantial contribution to the essay.

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Introduction

As the Kwacha teeters nears its all-time high of 22.670, which it initially reached in July 2021, the recent progress in Zambia's debt restructuring process illuminates a beacon of hope. The agreement, in principle, with Eurobond holders signals a step in the right direction. However, the FX market's underwhelming response starkly contrasts the positive reaction to the nation's Eurobond prices. Interestingly, the FX market has shrugged off this development, highlighting the lingering uncertainties and potential roadblocks that still lie ahead.

This scepticism arises because of the intricacies of the debt restructuring negotiations. While there is an agreement in principle with commercial creditors (Eurobond holders), a crucial concern looms in the background. It centres on the possibility that bilateral creditors may oppose one of the key terms agreed upon with commercial creditors, as it questions one of the International Monetary Fund's (IMF) critical principles of comparability of treatment, a paramount concern underpinning the debt treatment process. This divergence in interests could protract the negotiations and, in turn, cast a bearish shadow over the Kwacha's immediate prospects.

Furthermore, even if bilateral creditors find the terms agreeable, the government faces the obligation to make early amortization payments totaling USD 500 million, scheduled to begin as soon as December 2023. This substantial financial commitment is poised to draw down on the already precarious FX reserves, which currently stand at a meagre USD 2.8 billion or 3.0 months of import cover, as of July 2023.

Amidst these complexities, it is worth noting that a growing perception in the market views an increasing number of these announcements as being made without subsequent action. This perception has led to market fatigue, as market participants have observed a pattern where significant proclamations often coincide with periods of Kwacha weakness or during bond auction weeks. While this timing may raise questions about the intention of these announcements concerning market impact, it is essential to recognize that the aim is not to influence the direction of the Kwacha or the bond auction.

Instead, the authorities' eagerness to keep the market informed and updated, particularly in the context of ongoing debt restructuring efforts, could be reflected in these announcements. Zambia has been on a lengthy journey to finalize debt restructuring, and any positive developments may prompt a desire to communicate them to the market promptly. Therefore, the intention may be more about keeping the communication channels open and ensuring that market participants are well-informed about progress rather than actively trying to influence market dynamics.

Given this backdrop, the Kwacha's short-term outlook remains mired in uncertainty and vulnerability. To address these challenges and mitigate the potential risks, a multifaceted approach that includes aggressive policy actions from the Bank of Zambia (BOZ) becomes imperative. One such measure is a substantive adjustment in the cash reserve ratio, designed to recalibrate liquidity and exert upward pressure on the Kwacha, thus countering inflationary pressures.

In light of these dynamics, this advisory essay aims to present a comprehensive set of recommendations that extend beyond the debt restructuring and reserve ratio adjustment processes. We delve into measures to revamp the FX market structure, promote transparency, encourage market participation, and ensure that the Kwacha finds solid ground amid these uncertain times. Informed by economic principles and accessible to a broader audience, these recommendations align with the intent of this advisory report to provide insightful perspectives on potential pathways for consideration.

Review Dollarization of Mining Tax Policy

One of our advisory's central pillars is the critical need for a thorough reassessment of Zambia's mining tax policy. Historically, mining companies exchanged their earnings in USD for Kwacha to fulfill their tax obligations. However, the existing system hinders the flow of USD into the FX market, ultimately contributing to the instability of the Kwacha. To mitigate this issue, Zambia should revisit a policy to reintroduce much-needed dollar liquidity into the FX market to stabilize the Kwacha.

A pertinent point of contention arises because the BOZ argues that a significant portion of the mining taxes finds its way back into the FX market through a more equitable distribution process than the previous ringfencing by "Blue Banks." However, it is essential to note that the central bank typically releases USD into the market only when there is an overwhelming demand. Regrettably, the central bank often falls short of meeting the demand with the quantities it supplies, leaving market participants grappling with a persistent scarcity of USD.

This scarcity of USD perpetuates a culture of hoarding dollars among market participants. The prevailing sentiment is one of mistrust in the Kwacha's stability, as it consistently experiences pressure. This mistrust, in turn, fosters a cycle where market players are reluctant to convert their dollars into Kwacha, fearing further depreciation. The result is a market environment where people eagerly buy dollars whenever even the slightest dip in the dollar price occurs, further exacerbating the Kwacha's depreciation.

In contrast, the previous system allowed mining companies to sell their USD earnings into the FX market to fulfill their local currency obligations on-demand, at their discretion, irrespective of market supply and demand dynamics. This flexible approach encouraged market participants to transact with USD as needed without the encumbrance of a constrained supply system. In brief, we can characterize the prevailing policy as one whose initial intent may have been sound; however, it inadvertently exacerbated the issue it aimed to alleviate.

For reference, Australia is a prime example of a country where mining companies remit taxes in the local currency, the Australian dollar (AUD). By reinstituting a similar approach, Zambia could stabilize the Kwacha and alleviate its dependence on frequent central bank interventions to manage currency volatility.

The Australian model showcases the feasibility and potential benefits of accepting mining taxes in the local currency. This policy contributes to the overall stability of the Australian Dollar by ensuring a steady influx of USD into the FX market. This increased liquidity helps maintain a more balanced exchange rate, reducing the need for frequent interventions by the central bank.

Amend the IFEM

The Interbank Foreign Exchange Market (IFEM) framework in Zambia plays a pivotal role in the country's FX market. However, our advisory underscores the necessity for substantial amendments to this framework to invigorate market dynamics. The current punitive measures, including administrative sanctions, monetary penalties, suspension or revocation of the Authorized Dealer's dealing license, and even legal prosecution for fraudulent cases, in the event of IFEM breaches, inadvertently have a chilling effect on trading activity rather than addressing manipulative practices.

The challenge lies in the need for more clarity regarding what constitutes a breach of the IFEM. In many cases, merely buying USD from the FX market when the Kwacha is under pressure could lead to punitive actions. Paradoxically, selling USD into the FX market when the Kwacha appreciates does not evoke the same degree of scrutiny from the BOZ.

For a more vibrant and responsive FX market, it is imperative to transition toward a more nuanced regulatory framework. Instead of penalizing routine trading activities, the emphasis should be on targeting genuinely manipulative behaviours. This shift in approach could restore market participants' confidence and incentivize active trading.

The Central Bank of Malaysia, Bank Negara Malaysia, employs a similar approach to managing its FX market. Breaches in their FX regulations do not focus on buying or selling currencies under specific conditions. Instead, the focus is on preventing market manipulation and ensuring fair practices. This approach has encouraged healthy participation in Malaysia's FX market.

In this context, the Bank of Zambia can introduce advanced technology solutions such as Algorithmic Monitoring and AI-powered surveillance. These innovations entail implementing advanced algorithms and artificial intelligence (AI) systems to monitor FX market activities in real-time. Such technology empowers the BOZ to detect manipulative behaviours more effectively and initiate appropriate actions promptly.

A revamped regulatory framework should couple flexible pricing regulations that empower dealers to adjust spreads during heightened volatility or liquidity shortages. Flexible pricing regulations are crucial for dealers to adapt to market conditions effectively. Currently, `the fixed maximum spread of 0.05 Kwacha amplifies volatility rather than contains it. Allowing dealers to widen spreads during high volatility would prevent hot potato trading and market instability.

By providing dealers with this flexibility, Zambia can align itself with the practices of advanced FX markets and establish a solid foundation for market stability. For example, the European Central Bank (ECB) allows market participants to adapt their spreads in response to market conditions, striking a balance between maintaining orderly markets and preventing excessive trading costs.

Alternatively, if the BOZ prefers to maintain spreads, it can consider an Algorithmic Spread Adjustment approach. In this scenario, AI algorithms would dynamically adjust bid-ask spreads based on real-time market conditions. These algorithms can consider various data points to determine fair spreads, enhancing market efficiency.

Local Currency Settlement

Uganda offers an illuminating example of the benefits of promoting local currency settlement in specific sectors of the economy. This practice serves to curtail the demand for USD in transactions, which, in turn, contributes to the stability of the Ugandan Shilling (UGX). We cannot overstate the importance of this approach as it represents a strategic move to insulate the domestic currency from undue external pressures.

The rationale behind local currency settlement is reducing the economy's dependence on foreign currency, particularly the USD, in everyday transactions. By encouraging businesses and individuals to transact in the local currency, authorities can effectively manage and stabilize exchange rates, which, in turn, bolsters economic confidence.

To implement local currency settlement effectively, Zambia can consider several measures. Establishing clear and supportive regulations that mandate or incentivize local currency usage in specific sectors is vital. Authorities can launch public awareness campaigns to educate businesses and the public about the advantages of local currency settlement. Collaboration with financial institutions and businesses to facilitate the transition to local currency settlement and continuous monitoring and evaluation to assess policy effectiveness is crucial.

The advantages of local currency settlement are numerous. It reduces the country's vulnerability to external economic shocks, enhances economic self-sufficiency, and can lead to increased confidence in the domestic currency. However, it is crucial to carefully consider potential risks, such as resistance from businesses accustomed to trading in USD and the need for robust regulatory oversight to prevent abuse or circumvention of the system.

Indeed, the previous attempt at local currency settlement and its subsequent failure raises crucial considerations when revisiting this proposal. It is essential to recognize that people tend to transact in the currency they perceive as the most stable and reliable. Therefore, any effort to promote local currency settlement must address this fundamental preference for stability.

Comparing Zambia to South Africa, where exchange controls play a pivotal role, offers valuable insights. In South Africa, exchange controls have been in place for an extended period. These controls require individuals and entities to provide valid reasons for converting any amount of the local Rand into foreign currencies. It is only feasible for individuals to walk into any bank or currency exchange bureau and convert local currency into foreign currency if they provide a valid economic reason. Such controls aim to prevent the abuse or circumvention of the system.

To make local currency settlement a viable proposition, Zambia could explore the implementation of exchange controls or similar mechanisms. Such mechanisms would require individuals or entities to provide valid economic justifications for converting the local currency into foreign currency, aligning with the principles of stability and transparency. Implementing exchange controls could safeguard against unwarranted currency fluctuations and promote using the Kwacha for transactions within the country.

However, it is essential to approach this with caution and learn from past experiences. Here, as well, effective communication and public awareness campaigns will be necessary to ensure that individuals and businesses understand the rationale behind these controls and the benefits they can bring to stability and economic growth.

The BOZ's recent efforts to promote the domiciliation of export proceeds align with this objective. Other countries have successfully implemented similar policies. For instance, Ghana introduced the "Ghana Export-Import Bank (EXIM)" to oversee the management of export proceeds. This initiative ensures that earnings from exports are kept within the country's banking system, reducing reliance on offshore accounts. By ensuring the domiciliation of export proceeds within the Zambian banking system, the country can gain more control over its foreign exchange earnings and the flow of foreign currency.

Pairing the domiciliation of export proceeds with promoting local currency usage and incentivizing conversion into local currency forms a strategic approach to fortify the Kwacha and enhance economic stability. This regulatory control sets the stage for promoting the Kwacha as the primary currency for transactions within the country.

To achieve this, the central bank and government can implement policies that make it advantageous for businesses and individuals to convert their foreign currency earnings into Kwacha. These policies may include offering favourable exchange rates or reducing transaction fees for Kwacha-based transactions. By providing these incentives, adopting the local currency becomes an attractive choice, encouraging its use in daily transactions. For instance, Nigeria's Central Bank introduced the "Naira for Dollar" initiative, offering an enticing incentive to exchange remittances denominated in US dollars into the local currency at a favorable conversion rate. The primary objective of this policy is to bolster the nation's foreign exchange reserves while simultaneously encouraging the use of the domestic currency for various transactions.

That said, it is crucial to strike a balance. Overregulation can stifle economic activity, so a well-calibrated approach that encourages stability while allowing for necessary economic transactions is paramount. Introducing exchange controls and domiciliation of export proceeds can support local currency settlement in Zambia. While past failures highlight challenges, a carefully planned and communicated strategy can address these issues and ultimately contribute to the stability of the Kwacha.

Emergency Dollar Liquidity Facilities

Introducing mechanisms for emergency dollar liquidity is crucial for maintaining market stability, particularly in the face of persistent structural challenges where dollar demand consistently exceeds supply. These complexities, compounded by the delicate state of Zambia's FX reserves, demand innovative solutions.

One innovative approach to address these challenges is the concept of 'Reserve Allocation for Strategic Intervention' (RASI). Under RASI, the BOZ allocates and dedicates a predetermined portion of its FX reserves to potential interventions during periods of excessive dollar demand. This designated reserve pool acts as a strategic buffer, allowing the BOZ to respond swiftly to market pressures and uphold stability.

The practical implementation of RASI relies on the BOZ's capacity to become a more proactive and accurate forecaster of dollar demand. To achieve this, the central bank must establish real-time data units equipped to monitor various economic indicators, trade flows, and the dynamics of imports and exports. These units can create a dynamic dashboard that provides up-to-the-minute insights into currency demand. Leveraging innovative technology and data analytics, the BOZ can make data-driven decisions to manage currency demand efficiently.

For example, the Monetary Authority of Singapore (MAS) utilizes advanced data analytics and real-time monitoring to manage its FX reserves effectively. This approach allows MAS to anticipate market trends and strategically allocate reserves, ensuring the stability of its currency.

In addressing structural challenges where persistent dollar demand exceeds supply while also managing moral hazard, the BOZ can embrace cutting-edge technology and financial innovation. One such innovation is the 'Smart Liquidity Door' (SLD), which leverages blockchain technology and smart contracts to streamline accessing emergency dollar liquidity. When banks face excessive demand for dollars, they can access the SLD, which employs real-time data and predefined criteria to evaluate the legitimacy of their requests. This system ensures that banks receive liquidity only when genuine market stress is detected, reducing the likelihood of unwarranted requests.

This innovative approach not only guarantees the integrity of emergency liquidity provision but also positions Zambia as a pioneer in financial technology adoption. It balances between supporting market stability and safeguarding against moral hazard, all while embracing state-of-the-art solutions.

The journey toward resilience and innovation does not conclude with the SLD. To this end, we propose the establishment of an FX Dollar Redistribution Mechanism, a pioneering approach that integrates cooperative collaboration and technological advancement into the core of Zambia's FX market. At the heart of this innovative concept lies creating a state-of-the-art digital platform exclusively dedicated to FX dollar transactions. This platform empowers participating banks, breaking down traditional barriers and fostering cooperation among market participants. The rationale behind this mechanism is grounded in recognizing the persistent structural challenges within the FX market.

Within this digital landscape, real-time visibility is a fundamental feature. The platform monitors the flow of dollars among participating banks in real-time, offering a precise gauge of market dynamics. Larger banks, holding surplus dollars, can readily list their offerings, while smaller banks, often facing supply shortages, can signal their immediate needs. The introduction of algorithms ensures that the exchange of dollars is precise, matching sellers and buyers efficiently and fairly. This approach mitigates the risk of undue market disruptions, fostering a harmonious marketplace.

Central to this cooperative marketplace is the central bank's pivotal role. Positioned to facilitate and bridge gaps, the central bank ensures that dollars flow uninterrupted to where they are most needed. With the BOZ acting as a backstop or provider of last resort, it guarantees meeting legitimate demands, upholding market integrity, and building trust among market participants. Transparency plays a vital role in this mechanism, with every transaction transparently recorded in a ledger. This mechanism fosters an environment where manipulation is untenable, and historical transaction data provides banks with the necessary reference for confident participation.

Importantly, participation within this platform is voluntary, respecting the autonomy of financial institutions. Banks can choose to list their available dollars or access dollars as per their immediate requirements. Furthermore, banks that benefit from the central bank's assistance are encouraged to reciprocate by returning surplus dollars to the marketplace, perpetuating a virtuous cycle of resilience.

The benefits of the FX Dollar Redistribution Mechanism are manifold. It effectively addresses the concentration of dollars within larger banks, ensuring that smaller banks can access the currency necessary to fulfill their clients' needs in the FX market. Enhancing market transparency and efficiency reduces the risk of market disruptions and fosters greater trust among participants. Furthermore, this innovation positions Zambia as a pioneer in financial technology adoption, signaling a commitment to modernization and resilience within the FX market.

However, considerations abound. The mechanism must strike a delicate balance between encouraging cooperative participation and respecting banks' autonomy. Furthermore, the central bank should judiciously manage its role as a provider of last resort to prevent moral hazard. Careful design and implementation are essential to mitigate these risks.

Exchange Rate Targeting

Uganda's successful implementation of a managed float exchange rate regime provides a compelling model for Zambia to consider in its quest to reform the FX market. Under this approach, market forces influence the exchange rate within predetermined boundaries, striking a delicate balance between flexibility and stability. By adopting a similar managed float regime, Zambia can encourage market-driven exchange rates while retaining a degree of control to prevent excessive volatility.

The rationale behind this approach lies in its ability to harness the power of supply and demand dynamics within the FX market. It allows the Kwacha's value to respond organically to market conditions while providing a safety net to prevent extreme fluctuations that could undermine economic stability. This delicate equilibrium is conducive to attracting foreign investors and promoting a conducive environment for trade.

Singapore's Monetary Authority of Singapore (MAS) also utilizes a managed float regime to maintain exchange rate stability. The MAS allows the Singapore Dollar (SGD) to fluctuate within a specified band, ensuring flexibility while preventing wild oscillations. This approach has bolstered Singapore's status as a global financial hub with a stable currency, attracting investment and promoting economic growth.

The advantages of a managed float regime are multiple. It enables the market to play a more significant role in determining exchange rates, fostering transparency and efficiency. It also reduces the need for frequent central bank interventions, which can deplete foreign exchange reserves. Moreover, it provides businesses with a predictable currency environment, essential for long-term planning.

However, Zambia must tread carefully in implementing such a regime, considering its unique economic circumstances. While enhancing market dynamics, a managed float should accompany robust mechanisms to ensure adherence to the predetermined exchange rate bounds. Moreover, authorities should be able to intervene when necessary to prevent speculative attacks or excessive depreciation.

Revise Lending Regulations

A crucial aspect of our advisory pertains to revising lending regulations within Zambia. Currently, local banks face restrictions on lending in the local currency to international banks for less than a year. While this regulation intends to curtail volatility, it inadvertently hampers onshore trading and contributes to pricing disparities between onshore and offshore markets.

The rationale for revising these regulations is to strike a balance between limiting volatility and promoting onshore trading. By allowing local banks to engage in short-term lending transactions in the local currency with international counterparts, Zambia can bolster liquidity in its FX market and reduce pricing discrepancies between domestic and offshore markets. This move aligns with enhancing market dynamics and encouraging more robust trading activity.

For instance, the South African Reserve Bank (SARB) employs a similar approach, allowing local banks to engage in short-term lending transactions in the South African Rand (ZAR) with foreign counterparts. This practice contributes to increased liquidity in the South African FX market while providing mechanisms to manage volatility.

However, it is imperative to approach these regulatory revisions cautiously. The BOZ should carefully consider the exposure of local banks to international volatility and should explore alternative methods to mitigate volatility risks while maintaining a conducive environment for onshore trading. This consideration may include the development of hedging mechanisms or establishing clear guidelines for managing currency risk in onshore transactions.

Mandate ISDA/GMRA Documentation

To standardize trading relations and bolster the money market, the Bank of Zambia (BOZ) should contemplate making the use of interbank ISDA (International Swaps and Derivatives Association) and GMRA (Global Master Repurchase Agreement) documentation mandatory for all banks operating within the country's FX market.

Standardizing documentation is a fundamental step toward creating a more level playing field for banks of all sizes. It not only streamlines trading relations but also facilitates the extension of credit lines, particularly between larger and smaller banks. Additionally, it unlocks the potential of the money market for longer durations, providing stability and depth to the FX market.

In this context, the central bank can explore the introduction of Blockchain-Based Smart Contracts. By integrating blockchain technology, the BOZ can automate and standardize FX transactions through smart contracts. These blockchain-based contracts offer transparency, security, and efficiency in interbank dealings while minimizing compliance burdens.

The impending launch of the TradeClear guarantee facility represents a significant milestone in this direction. However, the cost implications of the guarantee facility, particularly for smaller banks, merit consideration. To address this, the BOZ could explore acting as a guarantor. By leveraging its comprehensive insights into the financial state of all banks, the central bank can mitigate compliance burdens and foster a more inclusive and efficient FX market.

Several central banks around the world have acted as guarantors in various capacities. For instance, the Reserve Bank of India (RBI) offers a guarantee for the settlement of government securities, ensuring the smooth functioning of the Indian financial market. Such guarantees can instil confidence among market participants and encourage participation.

Training Programs and Public Workshops

In the pursuit of fostering a more robust and knowledgeable FX market, the implementation of specialized training programs stands as a pivotal step. These programs hold the power to equip FX traders with the essential skills and expertise needed to effectively navigate the intricate terrain of market volatility and the substantial capital flows that characterize the field.

Furthermore, the convening of public workshops is an essential component of this endeavor. These workshops enlighten market participants about the intricacies of the revised regulations and their integral role in fostering fair and transparent trading practices. The significance of these initiatives transcends their immediate purpose; they not only enhance market confidence but also alleviate concerns associated with central bank actions.

Expanding the scope of these training and engagement initiatives to encompass the broader market, including corporates, is a logical progression. It is common for certain market players, especially corporates, to need a complete understanding of the implications of their actions in the FX market. Extending educational efforts to this significant market segment can encourage more responsible and informed behaviour, ultimately reducing the likelihood of actions that could disrupt market equilibrium.

Drawing inspiration from the Bank of England's comprehensive training programs for FX market participants, Zambia can ensure a high level of market expertise among traders and institutions. This practice has contributed significantly to the resilience and stability of the British Pound and the UK's FX market, setting a valuable precedent for enhancing market knowledge and confidence.

In an era where technological advancements are reshaping various industries, the BOZ has the opportunity to introduce cutting-edge technologies to enhance training programs. Augmented reality (AR) and virtual reality (VR) training programs for FX traders and corporates represent a forward-looking approach. VR simulations, for example, can faithfully replicate real market scenarios, enabling traders and corporates to practice decision-making in a risk-free environment. By donning AR headsets, participants can interact with virtual markets, gaining practical experience in a highly immersive environment.

Transparency and Communication

In the quest to nurture a mature and resilient FX market, enhancing transparency emerges as a foundational pillar. To realize this ambition, the Bank of Zambia (BOZ) must commit to publishing regular and comprehensive data encompassing various facets of FX trading activity, reserves, and market rates. This steadfast commitment to transparency carries the potential to minimize the lingering information asymmetry that has clouded the FX market and, in turn, fosters trust and credibility among market participants.

The rationale behind elevating transparency to a paramount status lies in its transformative power. Transparent markets are inherently more efficient and equitable. By providing timely and detailed data on trading activities, reserves, and market rates, the BOZ empowers market participants with valuable insights. It enables them to make informed decisions and navigate the market with greater confidence. In turn, this cultivates an environment conducive to healthy competition and fair play.

To leapfrog into the digital age and enhance transparency further, the BOZ should consider innovative approaches. One option is to create an interactive data dashboard that offers real-time access to FX market data, reserves, and rates. This user-friendly tool empowers market participants with instant insights, substantially enhancing transparency and trust. Alternatively, the BOZ can explore the development of a blockchain-based ledger to record all FX market data, including trading activity, reserves, and rates. Blockchain technology ensures data integrity and accessibility, further fostering trust among market participants.

For reference, we can draw inspiration from central banks in highly developed markets like the US Federal Reserve. The Fed consistently provides meticulous economic data and releases comprehensive monetary policy reports at regular intervals. This practice sets an elevated benchmark for transparency, ensuring that market participants are well-informed about the central bank's actions and intentions.

Furthermore, the Bank of Uganda merits recognition for its exemplary approach to transparent communication with market participants. Regular dialogues between central bank officials and market stakeholders have not only facilitated trust-building but also established effective channels for feedback. Such practices have been pivotal in instilling confidence and fostering cooperation in Uganda's FX market.

It is worth noting that a notable contrast exists between the transparency exhibited by central banks in developed markets and their counterparts in emerging economies. This glaring disparity underscores the imperative need for emerging markets like Zambia to enhance transparency significantly. Here, it is not just about mirroring the practices of developed markets but also recognizing the unique challenges and circumstances of each economy. Zambia must not only aim for transparency but also tailor its approach to address specific market dynamics.

Code of Conduct Review and Softening Aggressive Stance

Revising the code of conduct governing market participants constitutes a critical agenda item for the BOZ. This code should undergo meticulous revisions to align with international best practices, promoting clarity, fairness, and adherence to globally recognized norms. Moreover, it should not be a one-time effort but an ongoing process, with regular reviews to ensure its continued relevance and efficacy.

An equally significant aspect of this transformation entails a shift in the BOZ's approach to market interactions. Instead of adopting an aggressive stance, the central bank should consider a more consultative and collaborative approach when engaging with traders and stakeholders. This shift in approach cultivates an environment of mutual understanding and cooperation, ultimately encouraging greater market participation and adherence to market regulations.

The rationale behind these initiatives is rooted in the desire to foster a market environment that is not only rules-based but also characterized by fairness and transparency. An up-to-date code of conduct that adheres to international best practices enhances market integrity and builds participant trust. Moreover, by adopting a more consultative stance, the BOZ creates an atmosphere where market participants feel heard and valued, reducing the likelihood of adversarial relationships and conflicts.

For reference, the Bank of England is a noteworthy example. The institution maintains a dynamic code of conduct that evolves with changing market conditions and practices. Moreover, it fosters a consultative and collaborative approach with market participants, ensuring that regulations are not only practical but also responsive to market needs.

The BOZ can explore innovative approaches to enhance self-regulation within the FX market. One avenue to consider is the establishment of a Market-Based Self-Regulatory Body. This body could comprise industry experts and stakeholders tasked with developing and enforcing a code of conduct, thereby reducing the need for direct central bank intervention. While the Financial Markets Association of Zambia is a natural candidate for such a role, it would require much deeper empowerment and support from the Bank of Zambia.

Here, as well, the BOZ can harness the power of AI-driven compliance monitoring tools. These tools could continuously assess market participants' adherence to the code of conduct, efficiently identifying potential violations and recommending corrective actions in real-time.

Regulatory Sandboxes

Another avenue to explore is the establishment of fintech regulatory sandboxes. These sandboxes provide a controlled environment where pioneering FX market solutions can be tested and refined. They foster experimentation and innovation while ensuring compliance with existing regulations. In doing so, Zambia can position itself as a global leader in financial technology adoption, propelling its FX market into the forefront of modernization.

Consider the success stories of other countries that have harnessed fintech innovation to advance their financial markets. Singapore, for instance, has thrived as a fintech hub, attracting talent and investment while pushing the boundaries of what is possible in FX trading. By embracing technology-driven solutions and offering a platform for experimentation, Zambia can similarly position itself as a forward-thinking hub for FX trading and financial services.

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A Digital Kwacha

Our advisory report concludes with the most formidable yet transformative recommendation: the introduction of a Central Bank Digital Currency (CBDC), often referred to as a digital Kwacha. We position this innovative step as the final cornerstone in our comprehensive approach to revitalizing and strengthening the FX market structure, all to fortify Kwacha's stability.

The rationale behind considering a digital Kwacha is rooted in its potential to address persistent issues that have hampered Zambia's FX market. By facilitating seamless FX transactions through a digital platform, the CBDC can introduce unparalleled transparency and efficiency to the market. This transformation has already gained traction in Africa, with several central banks considering or implementing similar initiatives. For instance, Nigeria recently introduced the digital Naira (eNaira) to modernize its payment system and foster financial inclusion.

The advantages of this innovative step are numerous. One of the primary benefits lies in its potential to simplify cross-border transactions. This capability will become increasingly significant as Zambia navigates the impending African Continental Free Trade Area (AfCFTA). Given Zambia's reliance on international trade, a digital Kwacha can significantly expedite and streamline cross-border payments, positioning the country favorably within this emerging trade bloc.

Moreover, the introduction of a digital Kwacha has the potential to promote financial inclusion, a significant concern in many emerging markets, including Zambia. A considerable portion of the population needs access to traditional banking services. The CBDC can bridge this gap by offering financial services to the unbanked and underbanked, making FX transactions accessible to a broader audience.

However, it is imperative to acknowledge that this transition is full of challenges. Chief among these concerns is the imperative of cybersecurity. A robust framework of security measures is indispensable to shield against cyber threats and ensure the integrity of transactions. Addressing issues related to privacy and data protection will be pivotal to instilling user confidence in the CBDC. Moreover, the success of this initiative hinges substantially on user adoption and comprehensive educational efforts.

The integration of mobile network operators (MNOs) into the digital Kwacha ecosystem presents an opportunity to amplify financial inclusion further and facilitate access to FX transactions. MNOs have played a pivotal role in serving the underbanked populace through mobile payment solutions, effectively narrowing the gap in traditional banking services.

The digital Kwacha can synergize with the efforts of MNOs by providing a secure and regulated platform for FX transactions. This synergy offers individuals, including those without traditional bank accounts, a convenient avenue to access foreign exchange services through their mobile devices. For instance, individuals can seamlessly convert Kwacha to dollars or vice versa via the digital Kwacha while simultaneously benefiting from the security and transparency inherent in a central bank-backed digital currency.

Furthermore, MNOs can leverage their extensive networks and outreach capabilities to advocate for adopting the digital Kwacha across a broader spectrum of users. They can provide user-friendly interfaces and support services, ensuring that even individuals with limited technological proficiency can engage in FX transactions with ease.

Nonetheless, it is imperative to recognize that the collaboration between the digital Kwacha and MNOs, while brimming with promise, is full of regulatory and interoperability challenges. Establishing a robust regulatory framework is pivotal to govern the integration of MNOs into the FX market, guaranteeing adherence to anti-money laundering (AML) and know-your-customer (KYC) standards. Additionally, authorities must direct concerted efforts toward crafting interoperable systems that facilitate seamless transactions between the digital Kwacha and diverse mobile payment platforms.

The proposition for a digital Kwacha, in conjunction with the integration of MNOs, has the potential to usher in a revolution in FX transactions within Zambia. By harnessing the potential technology and mobile accessibility, this initiative can accentuate financial inclusion, strengthen Kwacha stability, and align Zambia strategically with the evolving dynamics of the African Continental Free Trade Area. That said, it is imperative to approach this transformation with meticulous planning, stringent risk management, and unwavering commitment to maximize its benefits for the Zambian economy.

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In conclusion, the comprehensive roadmap we have meticulously crafted is a holistic strategy that encompasses a broad spectrum of initiatives. These recommendations, drawn from successful practices worldwide, are designed to fortify the FX market structure and reinforce the stability of the Kwacha. By embracing these comprehensive recommendations, combining financial expertise with cutting-edge technology and innovative regulatory practices, Zambia can unlock the full potential of its FX market.

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Dean N Onyambu is the Executive Head of Trading at Opportunik Global Fund (OGF), a CIMA-licensed fund for Africans and diasporans (Opportunik ), and is a co-author of Unlocking African Prosperity . Passion and mentorship have fueled his 15-year journey in financial markets. He is a proud former VP of ACI Zambia FMA (@ACIZambiaFMA ) and founder of mentorship programs that have shaped and continue to shape 63 financial pros and counting! When he is not knee-deep in charts, he is all about rugby. His motto is exceeding limits, abounding in opportunities, and achieving greatness. #ExceedAboundAchieve

For more insights from Dean, you can follow him on LinkedIn @DeanNOnyambu ,? X @InfinitelyDean , or Facebook @DeanNathanielOnyambu .