The Bank of Tanzania is buying too much foreign exchange in the market and consequently driving up interest rates in the economy. And, if the trend continues the Tanzania shilling will continue appreciating against other hard currencies thereby undermining the countrys export competitiveness.
These are the conclusion of a new report by the Economic Division of banking conglomerate Standard Chartered Bank.
Lately, the money market in Tanzania has been unusually tight, a sign that there isnt enough money circulating in the market.
The tell-tale signs are the manner in which both interest rates and the Tanzania shilling has been behaving. The overnight lending rate which is the rate at which banks with flush cash lend out to those in a deficit position at the end of a days trading has spiked to a high of 25 per cent while the dollar rate has plunged from levels of 1,235/45 at the end of September, to levels of 1,130/40 this week.
Indeed, the money market in Tanzania is going through an unprecedented volatility. Standard Chartered Bank has advanced two reasons for the tightness of the money market.
First, that part of it stems from the traditional end-quarter tightening of Tanzania shilling liquidity, as corporates make tax payments to the fiscal authorities. Second, that the situation has been made worse by the announcement by the Bank of Tanzania that it would continue to sterilise domestic liquidity by selling foreign exchange.
Despite making significant progress with domestic revenue collection in recent years, Tanzania remains dependent on donors for the financing of its Budget. This year, development partners will finance around 42 per cent of the Budget. As a result, Tanzania sees sizeable inflows, which are typically converted to local currency disbursed to various ministries, and spent. The report by Standard Chartered suggests that these flows need to be sterilised in order to keep domestic money supply growth under control.
Traditionally, there have been two ways of doing this. First, issuance of T-bills and, second, foreign exchange sales.
However, Tanzania appears to have expressed a preference for foreign exchange sales. With interest rates already at a high level, Finance Minister Zakia Meghji pledged in this years Budget speech not to compromise macroeconomic stability by issuing debt securities to finance the Budget.
The International Monetary Fund (IMF), in its latest consultation with Tanzania also gave its support to increased reliance on foreign exchange sales to contain liquidity, noting that this would help to ease pressure on T-bill yields, although stressing that the appropriate balance in the use of liquidity management instruments will still need to be found. Since last years drought, inflation has remained above the Bank of Tanzanias targeted 5 per cent level, and the effort to mop up liquidity has intensified. As a means of liquidity control, the IMF has urged the transfer of government deposits from commercial banks to the Central bank which has added to the market tightness.
Could Tanzania do what Uganda did recently to address the volatility in the market? When the Uganda shilling was appreciating unpredictably in June of this year, the authorities in the more-liberalised country cancelled two consecutive T-bill auctions over the course of a month. The resulting injection of liquidity into the economy was sufficient to reverse the sharp appreciation of the Uganda shilling.
But can Tanzania temporarily abandon its sterilisation effort until more normal liquidity conditions are restored?
The conclusion of the report is that this is unlikely to happen in Tanzania because of the shallowness of its markets and less experience with managing such situations.
Until decisive action is taken by the BoT, and if it continues to engage in much more dollar buying than we have seen in the recent past, further strengthening of the Tanzania shilling is likely, says the report.