## Identifying Determinants of FX Stability in Mozambique ## Source details **Canonical URL:** [Identifying Determinants of FX Stability in Mozambique](https://www.imf.org/-/media/files/publications/wp/2024/english/wpiea2024233-print-pdf.pdf) ## Other formats - [Markdown version](/-/media/files/publications/wp/2024/english/wpiea2024233-print-pdf.pdf.md) - [Structured JSON version](/-/media/files/publications/wp/2024/english/wpiea2024233-print-pdf.pdf.json) --- ### Introduction and overview of recent exchange rate behavior - Since mid-2021, the Mozambican metical has remained stable against the US dollar, despite a de jure floating exchange rate. - Stability persisted amid climate shocks, an insurgency and internal displacement, changing extractive sector dynamics, and substantive changes in monetary and macroprudential policy. - Finding: While identified drivers cannot individually explain the stabilized exchange rate, they collectively establish the current equilibrium.1 - Hypothesized drivers supporting stability: - A preference by importers and exporters for a stable exchange rate. - The central bank’s attention to and understanding of strong exchange rate pass-through of imported inflation. - Market frictions: very shallow markets, highly concentrated FX supply, the mechanism for determining the daily reference rate, and supervision. 1 — “Leaning on terminology from game theory, we here use the term ‘equilibrium’ to describe a situation in which no agent has an incentive to change their behavior, rather than to refer to a market-determined equilibrium exchange rate level.” ### Background, market dynamics and regime history - De facto exchange rate regimes since independence: - I 1975–1986: Fixed - II 1987–1988: Market-determined - III 1989–1992: Crawling peg - IV 1993–1998: Floating - V 1999–2002: Independently floating - VI 2003–2007: Managed floating with no predetermined path for the exchange rate - VII 2008–2019: Floating - VIII 2020–2021: Crawl-like arrangement - IX 2021–2023: Stabilized arrangement - Key episodes: - Rapid devaluation in 1987–88 followed by a crawling peg. - Liberalization in 1994 and adoption of floating-rate regime. - Reclassification to a crawl-like arrangement in early 2020 after a 2 percent band depreciation against the dollar. - De facto stabilized arrangement established in mid-2021; stabilization persisted even as the Bank of Mozambique (BM) embarked on an easing cycle in January 2024. - Market structure: - FX market dominated by commercial banks, with a market share of over 99 percent. - About 15 banks and 4 foreign exchange bureaus authorized by the BM to buy and sell foreign exchange. - FX supply primarily originates in the extractive sector; changes in coal prices significantly affect available FX volumes. - Trading on the interbank market is minimal; banks make temporary intraday price adjustments not reflected in final closing levels or the reference rate. - Exchange rate measures: - REER has remained relatively stable around its historical average over the past two decades. - NEER depreciated significantly with major depreciation episodes in 2009–10 and following the 2016 “hidden debt” scandal. - Mid-2021 episode: unexpected monetary tightening in February 2021 triggered bilateral exchange rate appreciation by 26 percent, followed by a depreciation of 15 percent; stabilization followed sanctions on one domestic bank and a two-year suspension from exchange rate-related activities for fraudulent behavior. ### Trade and market flows (key products, partners, and balances) - Main product groups: - Megaprojects (mostly extractive industries), other industrial products, cash crops and food products. - Exports: - Dominated by aluminum, minerals, and agricultural cash crops. - Megaprojects (coal, aluminum, gas, heavy sands, electricity) contributed jointly to approximately 75 percent of overall exports in September 2023. - Main export destinations: India (19 percent), China (15 percent), South Africa (12 percent). - Imports: - Main imports: consumer goods (25 percent), machinery (17 percent), fuel (14 percent). - Over a quarter of imports come from South Africa, followed by South Korea (16 percent) and China (14 percent). - Machinery imports mainly related to megaprojects and financed by foreign direct investment. - Between 2009 and March 2023, FX demand to cover the bill for fuel imports was partly supplied by the BM at the reference market rate; policy phased out with provisions ending in June 2023. - Current account and trade balances (Million USD): - Current Account: 2017 (2,413) ; 2018 (4,436) ; 2019 (2,934) ; 2020 (3,869) ; 2021 (3,601) ; 2022 (6,295) - Excl. Megaprojects (Current Account): 2017 (3,515) ; 2018 (3,760) ; 2019 (3,581) ; 2020 (4,034) ; 2021 (4,679) ; 2022 (5,350) - Megaprojects (Current Account): 2017 1,102 ; 2018 (676) ; 2019 647 ; 2020 165 ; 2021 1,078 ; 2022 (946) - Trade Balance: 2017 (2,671) ; 2018 (4,831) ; 2019 (3,914) ; 2020 (4,291) ; 2021 (3,987) ; 2022 (6,503) - Excl. Megaprojects (Trade Balance): 2017 (3,764) ; 2018 (4,383) ; 2019 (4,577) ; 2020 (4,390) ; 2021 (5,864) ; 2022 (5,942) - Megaprojects (Trade Balance): 2017 1,093 ; 2018 (448) ; 2019 663 ; 2020 99 ; 2021 1,876 ; 2022 (561) - Financial Account: 2017 2,211 ; 2018 4,615 ; 2019 2,842 ; 2020 3,762 ; 2021 3,538 ; 2022 6,234 - Foreign Direct Investment (Financial Account component): 2017 2,293 ; 2018 1,903 ; 2019 3,410 ; 2020 3,035 ; 2021 5,102 ; 2022 1,975 - Interpretation: - Current account deficits widened as imports significantly exceeded exports driven mainly by imports of capital goods for megaprojects and consumer goods. - Large current account and trade deficits mostly financed by FDI inflows for megaprojects. - Even excluding megaprojects, current account and trade deficits remain high and have been mostly financed by FDI. ### Profile of market participants and sector exposures - Importers: - Fuel companies: approximately 14 percent of imports as of September 2023; fuel mostly sold locally in domestic currency; exchange rate depreciation increases import bill, with administered fuel prices typically passed through only in part and with a lag. - Megaprojects: approximately 17 percent of overall imports as of September 2023; expenses mainly Capex and debt service in foreign currency; broadly insulated from exchange rate fluctuations due to export orientation and access to foreign currency accounts. - Small importers: micro and small importers represented approximately 25 percent of overall imports in 2023; most transactions are cross-border trades averaging an estimated USD 3,075 million per year; South African rand dominates cross-border transactions. - Exporters and major cases: - Large exporters prefer FX stability because production is export-oriented, low domestic input content, and costs often priced in US dollars. - Vulcan Minerals: exports approximately USD 2.2 billion in 2022; production fully export-oriented; small share of onshore domestic payments in metical; estimated average labor cost share below 20 percent of total costs in Mozambique (based on South Africa data). - Hidroeléctrica de Cahora Bassa (HCB): about 73 percent of electricity production exported mainly to South Africa and billed in South African rands. - Electricidade de Moçambique (EDM): about 20 percent of electricity handled is exported; some wages and pensions partly fixed to US dollars. - MOZAL, SA (MOZAL): roughly 90 percent of aluminum production exported; about 53 percent raw materials denominated in dollars; over 21 percent electricity priced in rand; labor costs about 3 percent. - SASOL: sales mostly denominated in US dollars; operating costs in rand and US dollars. - Banking sector exposures (end-2022): - Approximately 20 percent of banks’ assets were in foreign currency. - Approximately 22 percent of liabilities were in foreign currency. - Approximately 16 percent of banks’ credit and 25 percent of banks’ deposits were in foreign currency. - Foreign liabilities over assets ratio stood at 98 percent in December 2022. - Approximately 87 percent of foreign liabilities are demand deposits. - Interpretation: Banking sector balance sheet partly protected, but short-duration liabilities versus longer-duration assets imply depreciation creates vulnerabilities. ### FX market legal and operational framework, interventions and reference rate methodology - Market described as oligopolistic competition with few significant FX providers; exporters previously “auctioned off” export proceeds to find most favorable rate, but exporter preferences for stability moderated incentives for spot-seeking. - Concentration of market power among a handful of exporters and banks increases scope for abuse of insider information (e.g., timing of FX supply). - BM regulatory actions: - June 2021: BM suspended Standard Bank from foreign exchange market operations and barred Chief Executive and other senior officers from executive functions in the financial industry for six years due to alleged fraudulent manipulation of the exchange rate, creation of an illegal payment system outside the country and irregular derivatives transactions. - Standard Bank accounted for almost half of FX turnover at time of suspension. - BM conducted onsite inspections at other large banks; heightened supervision likely affected market dynamics and participants’ willingness to deviate from the prevailing reference rate. - FX law requires all exporters to convert export receipts with the bank that provided the Letter of Credit and at the bank’s bid rate prevailing when export revenues are credited, intended to limit exporters from “auctioning” export revenues and ensure predictability. - FX intervention (FXI) framework objectives: - Address “disorderly” market conditions resulting from notable imbalances between demand and supply that significantly impact exchange rate volatility. - Accumulate and maintain adequate stock of international reserves to ensure compliance with external commitments and preserve market confidence in the national currency. - Reference rate methodology and effect on perceived volatility: - Current methodology calculates the reference rate as an average of quotes submitted by banks on a centralized platform three times a day; actual transactions are not part of the calculation. - Result: methodology hides existing volatility in transactions, producing an artificially stable reference rate. - Banks commonly submit the previous reference rate as their quote, resulting in the updated reference rate being equal to the previous one. - A revision to include actual transactions is planned for the end of 2024. - Statistically, variation in rates at which banks transact foreign exchange among each other and with clients is very small at an annualized weekly volatility of less than (figure cutoff in source). ### Indicators of exchange rate (dis)equilibrium and recent metrics - Parallel market premium: - Parallel FX market is comparatively small and cash based, often a “curb market.” - USD/MZN spreads: - From 2018 to 2020, USD/MZN spreads averaged 420 basis points, with the metical trading weaker on the parallel market. - For the same period, ZAR/MZN averaged approximately 80 basis points. - During metical stability starting mid-2021, USD/MZN parallel market spread has averaged around 500 basis points. - Limited growth of the parallel market and absence of large arbitrage opportunities suggest the official exchange rate may not be far from its equilibrium value. - Unfulfilled FX demand & wait time: - Open FX demand monitored via a central platform; two peaks in excess demand coincide with policy changes (2021 tightening and mid-2023 announcement that BM would no longer provide FX for fuel imports). - As of October 2024, banking sector’s approximation suggests around $440 million in unmet demand, excluding dividends. - Primary mechanism to address open demand has been increased wait time rather than large detachment of the parallel market. - In the second half of 2024, wait time for an average FX transaction extended to about three months, depending on type and amount of payments. - Bureaux de change volumes remain low compared to main market; parallel market small but experiencing growth, trading at a premium of about 15% in late 2024. - Net International Reserves and foreign currency supply: - Net international reserves recovered substantially in 2023: - USD 3.4 billion by end-December 2023 (or 3.5 months of projected 2023 non-megaproject imports). - Up from USD 2.7 billion at end-December 2022. - Exchange rate remained de facto stabilized against the dollar despite BM’s decision to no longer supply FX for fuel imports, indicating FX interventions were not the main cause of sustaining the exchange rate. - Absent other policy measures (such as required-reserve increases), the decision to stop providing FX could potentially have triggered a revaluation. ### Policymaker preference and macroprudential stance - Bank of Mozambique historically among most hawkish central banks in the region. - In 2021, BM started proactively hiking interest rates well before most other central banks and ahead of inflation accelerating substantially. - After inflation moderated from highs in 2022, BM kept policy stance very tight, with ex post real policy rates above 10 percent for an extended period of time. - BM concerned about depreciation’s impact on inflation via higher import prices; Aisen, Manguinhane and Simione (2021) estimate 50 percent of exchange rate variation passes through to prices in less than six months. - Macroprudential and regulatory tools used to support the currency: - Required reserve coefficients increased on multiple occasions, most recently to 39.0 percent for deposits in local currency and 39.5 percent for deposits in foreign currencies. - BM does not remunerate required reserves; the high required reserves ratio therefore acts as a tax on the financial system. - These measures reduced demand for foreign exchange by lowering liquidity and tightening financial conditions, counteracting pressures for depreciation. ### Discussion: why the de facto stabilized USD/MZN since mid-2021? - Factors working together to create a robust de facto stabilized exchange rate: - Policymaker preferences for low imported inflation: - High real policy rates - High required reserve coefficients - Aftereffects of supervision in early 2021 (sanctions and heightened inspections) - Market design with a reference rate that does not reflect actual transaction rates - Importer preferences for a stable FX to increase predictability - Exporter preferences for a stable FX due to US dollar-dominated cost structure - Market frictions: shallow markets and highly concentrated FX supply that increase risks associated with floating regimes - Resilience to shocks noted: Russia’s invasion of Ukraine, tropical cyclones, monetary policy easing beginning January 2024, and presidential elections did not destabilize the de facto peg. - Transition risks and triggers: - Breakout from current equilibrium likely depends on market sentiment, policy action, and market design changes. - Memories of past supervisory and regulatory events may fade; banks may become less reluctant to adhere to the equilibrium; monetary policy may become more accommodative in a low-inflation context. - Once the new reference-rate methodology is applied, volatility in transaction rates is expected to be reflected in the reference rate. - Policy guidance for navigating any transition: - Policymakers must carefully manage the transition to minimize disruption and disorderly market conditions. - BM should closely monitor emerging market pressures and adhere to its intervention policy to counteract disorderly conditions. ### Policy recommendations and implications - Short and medium-term policy considerations: - Maintain vigilant monitoring of market pressures when implementing changes to reference-rate methodology. - Use interventions in line with stated FXI policy to counteract disorderly market conditions as needed. - Manage required-reserve and macroprudential stance mindful of liquidity and FX demand effects. - Structural and market-development recommendations: - Implement proposed reference-rate methodology change (to include actual transactions) cautiously, with communication and transitional arrangements to avoid market disruption. - Deepen spot and money markets to reduce shallowness and excessive risk premia. - Promote development of FX hedging instruments to reduce exchange-rate risks for exporters and importers. - Encourage export diversification to reduce concentration in FX supply and facilitate a sustainable floating exchange rate over the medium to long term. ### Conclusion - The Mozambican FX market is de jure floating but does not fit the textbook free-floating market in practice. - Identified drivers of FX stability work collectively to establish a de facto stabilized exchange rate equilibrium since mid-2021. - Key contributors: policymaker preferences for low imported inflation, importers’ and exporters’ preferences for exchange-rate stability, market frictions (very shallow markets and concentrated FX supply), an unusual daily reference-rate mechanism, and aftereffects of supervision. - Indicators do not show increasing market pressure, suggesting the current exchange rate is not far from its fundamental equilibrium value. - Prospects for a more natural float over the medium to long term hinge on: - The proposed new methodology for calculating the reference rate (planned for 2024) translating transaction volatility into reference-rate volatility. - Developments in spot and money markets reducing shallowness and excessive risk premia. - Improved FX hedging options lowering exchange rate risks. - Export diversification reducing FX supply concentration and facilitating a floating exchange rate with lower risk of disorderly conditions. *Source: IMF Working Paper — Identifying Determinants of FX Stability in Mozambique (wpiea2024233-print-pdf).* ### Introduction ........................................................................................................... ### Identifying Determinants of FX Stability in Mozambique ### Introduction - Document structure includes: - Introduction ......................................................................................................................................................... 4 - Background and Market Dynamics ................................................................................................................... 5 - Trade and Market Flows ..................................................................................................................................... 8 - Profile of Market Participants ............................................................................................................................ 9 - FX Market Legal and Operational Framework and Dynamics ....................................................................... 12 - Policymaker Preference ................................................................................................................................... 14 - Indicators of Exchange Rate (Dis)Equilibrium ............................................................................................... 15 - Discussion ......................................................................................................................................................... 17 - Conclusion ......................................................................................................................................................... 17 - References ......................................................................................................................................................... 19 ### Background and Market Dynamics - Section present in document (page 5). ### Trade and Market Flows - Section present in document (page 8). ### Profile of Market Participants - Section present in document (page 9). ### FX Market Legal and Operational Framework and Dynamics - Section present in document (page 12). ### Policymaker Preference - Section present in document (page 14). ### Indicators of Exchange Rate (Dis)Equilibrium - Section present in document (page 15). ### Discussion - Section present in document (page 17). ### Conclusion - Section present in document (page 17). ### Glossary and Abbreviations - AREAER Annual Report on Exchange Arrangements and Exchange Restrictions - BM Bank of Mozambique - EDM Electricidade de Moçambique - FDI Foreign Direct Investment - FX Foreign Exchange - FXI Foreign Exchange Intervention - HCB Hidroeléctrica de Cahora Bassa - IMF International Monetary Fund - LNG Liquefied Natural Gas - MZN Mozambique metical - NEER Nominal Effective Exchange Rate - REER Real Effective Exchange Rate - USD United States dollar *Source: IMF Working Paper — Identifying Determinants of FX Stability in Mozambique (table of contents and glossary).* ### INTRODUCTION ### INTRODUCTION ### Overview of recent exchange rate behavior - Since mid-2021, the Mozambican metical has remained stable against the US dollar, even though the exchange rate is de jure floating. - Stability persisted despite extensive swings in economic conditions, including climate shocks, an insurgency and internal displacement, changing extractive sector dynamics, and substantive changes in monetary and macroprudential policy. - The report examines history of exchange rate regimes, market structure and regulation, role of market participants, policy measures, and other relevant factors to explain why the exchange rate has become de facto stabilized. - Finding: While identified drivers cannot individually explain the stabilized exchange rate, they collectively establish the current equilibrium.1 - Hypothesized drivers supporting stability: - A preference by importers and exporters for a stable exchange rate. - The central bank’s attention to and understanding of strong exchange rate pass-through of imported inflation. - Market frictions: very shallow markets, highly concentrated FX supply, the mechanism for determining the daily reference rate, and supervision. 1 — “Leaning on terminology from game theory, we here use the term ‘equilibrium’ to describe a situation in which no agent has an incentive to change their behavior, rather than to refer to a market-determined equilibrium exchange rate level.” ### Background and market dynamics and regime history - Mozambique’s de facto exchange rate regimes since independence: - I 1975–1986: Fixed - II 1987–1988: Market-determined - III 1989–1992: Crawling peg - IV 1993–1998: Floating - V 1999–2002: Independently floating - VI 2003–2007: Managed floating with no predetermined path for the exchange rate - VII 2008–2019: Floating - VIII 2020–2021: Crawl-like arrangement - IX 2021–2023: Stabilized arrangement - Key episodes: - Rapid devaluation in 1987–88 followed by a crawling peg. - Liberalization in 1994 and adoption of floating-rate regime. - Reclassification to a crawl-like arrangement in early 2020 after a 2 percent band depreciation against the dollar. - A de facto stabilized arrangement established in mid-2021; stabilization persisted even as the Bank of Mozambique (BM) embarked on an easing cycle in January 2024. - Market structure notes: - FX market is dominated by commercial banks, with a market share of over 99 percent. - About 15 banks and 4 foreign exchange bureaus are authorized by the BM to buy and sell foreign exchange. - FX supply primarily originates in the extractive sector; changes in coal prices significantly affect available FX volumes. - Trading on the interbank market is minimal; banks make temporary intraday price adjustments that are not reflected in final closing levels or the reference rate. ### Exchange rate measures and dynamics - Over the past two decades: - Real Effective Exchange Rate (REER) has remained relatively stable around its historical average. - Nominal Effective Exchange Rate (NEER) depreciated significantly, with major depreciation episodes in 2009–10 and following the 2016 “hidden debt” scandal. - REER repeatedly reverted to its long-run average; NEER experienced overall depreciation. - Mid-2021 stabilization details: - Following steady depreciation between September 2019 and February 2021, unexpected monetary tightening in February 2021 triggered: - Bilateral exchange rate appreciation against the US dollar by 26 percent, followed by a depreciation of 15 percent. - Exchange rate stabilized after BM sanctioned one domestic bank and issued a two-year suspension from exchange rate-related activities for fraudulent behavior. - Market participants generally did not voice strong opinions in favor of a devaluation. ### Trade and market flows - Main export and import product groups: - Megaprojects (mostly extractive industries), other industrial products, cash crops and food products. - Exports: - Dominated by aluminum, minerals, and agricultural cash crops. - Megaprojects (coal, aluminum, gas, heavy sands, electricity) contributed jointly to approximately 75 percent of overall exports in September 2023. - Main export destinations: India (19 percent), China (15 percent), South Africa (12 percent). - Imports: - Main imports: consumer goods (25 percent), machinery (17 percent), fuel (14 percent). - Over a quarter of imports come from South Africa, followed by South Korea (16 percent) and China (14 percent). - Machinery imports mainly related to megaprojects and financed by foreign direct investment. - Between 2009 and March 2023, FX demand to cover the bill for fuel imports was partly supplied by the BM at the reference market rate; policy phased out with provisions ending in June 2023. - Current account and trade balances (Million USD): - Current Account: 2017 (2,413) ; 2018 (4,436) ; 2019 (2,934) ; 2020 (3,869) ; 2021 (3,601) ; 2022 (6,295) - Excl. Megaprojects (Current Account): 2017 (3,515) ; 2018 (3,760) ; 2019 (3,581) ; 2020 (4,034) ; 2021 (4,679) ; 2022 (5,350) - Megaprojects (Current Account): 2017 1,102 ; 2018 (676) ; 2019 647 ; 2020 165 ; 2021 1,078 ; 2022 (946) - Trade Balance: 2017 (2,671) ; 2018 (4,831) ; 2019 (3,914) ; 2020 (4,291) ; 2021 (3,987) ; 2022 (6,503) - Excl. Megaprojects (Trade Balance): 2017 (3,764) ; 2018 (4,383) ; 2019 (4,577) ; 2020 (4,390) ; 2021 (5,864) ; 2022 (5,942) - Megaprojects (Trade Balance): 2017 1,093 ; 2018 (448) ; 2019 663 ; 2020 99 ; 2021 1,876 ; 2022 (561) - Financial Account: 2017 2,211 ; 2018 4,615 ; 2019 2,842 ; 2020 3,762 ; 2021 3,538 ; 2022 6,234 - Foreign Direct Investment (Financial Account component): 2017 2,293 ; 2018 1,903 ; 2019 3,410 ; 2020 3,035 ; 2021 5,102 ; 2022 1,975 - Interpretation: - Current account deficit widened as imports significantly exceeded exports driven mainly by imports of capital goods for megaprojects and consumer goods. - Large current account and trade deficits mostly financed by FDI inflows for megaprojects. - Even excluding megaprojects, current account and trade deficits remain high and have been mostly financed by FDI. ### Profile of market participants - Importers: - Fuel Companies: - Account for approximately 14 percent of imports as of September 2023. - Fuel mostly sold locally in domestic currency; exchange rate depreciation increases import bill, with administered fuel prices typically passed through only in part and with a lag. - Megaprojects: - Account for approximately 17 percent of overall imports as of September 2023. - Expenses mainly Capex and debt service in foreign currency; megaprojects broadly insulated from exchange rate fluctuations due to export orientation and access to foreign currency accounts. - Liquefied natural gas (LNG) projects contribution to imports expected to increase from 2024 as Total’s Mozambique LNG project is expected to resume activity. - Small importers: - Micro and small importers (mainly consumption goods) represented approximately 25 percent of overall imports in 2023. - Most transactions are cross-border trades averaging an estimated USD 3,075 million per year. - South African rand dominates cross-border transactions; micro and small importers sensitive to ZAR/MZN exchange rate fluctuations. - Exporters: - Large exporters prefer FX stability because: - Low domestic input content and export-oriented production often priced in US dollars. - Depreciation increases production costs almost proportionally; limited gains in competitiveness. - Predictability from low FX volatility reduces uncertainty. - Major exporter cases: - Vulcan Minerals: - Operator of Moatize coal mine; Mozambique’s largest company in 2021 and largest exporter in 2022, with exports reaching approximately USD 2.2 billion. - Production fully export-oriented; most costs tied to foreign currency and payments through offshore accounts; small share of onshore domestic payments in metical. - Coal mining is capital-intensive; estimated average labor cost share below 20 percent of total costs in Mozambique (based on South Africa data). - Depreciation expected to have limited impact on profitability; depreciation increases cost of living for employees, potentially reducing labor productivity and increasing absenteeism and collective action. - Hidroeléctrica de Cahora Bassa (HCB): - About 73 percent of electricity production exported mainly to South Africa (ESKOM) and billed in South African rands in the context of long-term contracts. - Most operational costs are in meticais; some maintenance services paid in dollars. - Comparative exposure to metical-rand exchange rate movements; recent appreciation of metical against the rand likely negatively impacted HCB. - Electricidade de Moçambique (EDM): - About 20 percent of electricity handled is exported to neighboring countries. - Operational costs include electricity and electrical material mainly from Eskom, HCB and IPP’s with prices referenced in rand and the US dollar. - EDM has partly fixed some wages and pensions to US dollars. - MOZAL, SA (MOZAL): - Roughly 90 percent of aluminum production exported; 10 percent sold locally to Midal Cables with contracts in US dollars. - Cost structure: about 53 percent raw materials (imported and denominated in dollars); over 21 percent electricity with prices set in rand; labor costs about 3 percent. - SASOL: - Sales mostly denominated in US dollars; gas produced almost wholly exported under long-term contracts to Sasol mother company and international customers. - Most operating costs in rand and US dollars; funding sourced from shareholders in rand or dollars. - Fluctuations of rand-dollar exchange rate have greater impact on Sasol than metical exchange rate. - Banking sector: - FX balance sheet mismatches are limited but create vulnerability to exchange rate volatility. - At end-2022: - Approximately 20 percent of banks’ assets were in foreign currency. - Approximately 22 percent of liabilities were in foreign currency. - Approximately 16 percent of banks’ credit and 25 percent of banks’ deposits were in foreign currency. - Foreign liabilities over assets ratio stood at 98 percent in December 2022. - Approximately 87 percent of foreign liabilities are demand deposits. - Interpretation: Banking sector balance sheet partly protected, but short-duration liabilities versus longer-duration assets imply depreciation creates vulnerabilities. ### FX market legal and operational framework, interventions and reference rate methodology - Prior to mid-2021 volatility: - USD/MZN volatility was consistently positive but lower than comparators. - Market structure described as oligopolistic competition with few significant FX providers; exporters previously “auctioned off” export proceeds to find most favorable rate. - Exporters’ longer-term preference for stability (to protect workers’ living costs) moderated incentives to seek short-term favorable spot transactions. - Concentration of market power among a handful of exporters and banks increases scope for abuse of insider information (e.g., timing of FX supply). - BM regulatory actions to limit disorderly behavior and volatility: - June 2021: BM suspended Standard Bank from foreign exchange market operations and barred Chief Executive and other senior officers from executive functions in the financial industry for six years due to alleged fraudulent manipulation of the exchange rate, creation of an illegal payment system outside the country and irregular derivatives transactions. - Standard Bank accounted for almost half of FX turnover at time of suspension. - BM conducted onsite inspections at other large banks; heightened supervision likely affected market dynamics and participants’ willingness to deviate from the prevailing reference rate. - FX law requirements: - Requires all exporters to convert export receipts with the bank that provided the Letter of Credit and at the bank’s bid rate prevailing at the moment when export revenues are credited, intended to limit exporters from “auctioning” export revenues and ensure predictability. - FX intervention (FXI) framework objectives: - Address “disorderly” market conditions resulting from notable imbalances between demand and supply that significantly impact exchange rate volatility. - Accumulate and maintain adequate stock of international reserves to ensure compliance with external commitments and preserve market confidence in the national currency. - BM interventions charted (Figure 8): BM interventions on the FX market reported in USD million (source: Bank of Mozambique and IMF Staff Calculations). - Reference rate methodology and its effect on perceived volatility: - Current methodology calculates the reference rate as an average of quotes submitted by banks on a centralized platform three times a day. - Actual transactions are not part of the calculation of the reference rate. - As a result, the methodology hides existing volatility in transactions, producing an artificially stable reference rate. - Statistically, variation in rates at which banks transact foreign exchange among each other and with clients is very small at an annualized weekly volatility of less than (figure cutoff in source). ### Implications and potential future dynamics - Market improvements and export diversification could lead to a more natural floating exchange rate. - A proposed new methodology for calculating the reference rate will likely translate existing transaction rate volatility to reference rate volatility. - A deeper market for hedging instruments might allow exporters and importers to reduce exchange rate risks even in the absence of a fixed exchange rate. - Over medium and long term, export diversification could reduce concentration in FX supply and pave the way for a floating exchange rate with reduced risk of disorderly market conditions. - This analysis is backward-looking and not an exchange rate valuation exercise; it focuses on why the exchange rate has been de facto stabilized since mid-2021 rather than on fundamentals or valuation. The External Sector Assessment in the 2024 Staff Report discusses exchange rate fundamentals and valuation. *Source: INTRODUCTION (wpiea2024233-print-pdf) — IMF Working Paper content provided.* ### 1.5 percent. As such, this measure of the exchange rate is also classified as a “stabilized arrangement” under ### Identifying Determinants of FX Stability in Mozambique ### POLICYMAKER PREFERENCE - The Bank of Mozambique (BM) has historically been among the most hawkish central banks in the region. - In 2021, the BM started proactively hiking interest rates well before most other central banks and ahead of inflation accelerating substantially. - After inflation moderated from its highs in 2022, the BM kept its policy stance very tight, with ex post real policy rates above 10 percent for an extended period of time. - The BM is concerned about depreciation’s impact on inflation via higher import prices; Aisen, Manguinhane and Simione (2021) estimate that the exchange rate pass-through in Mozambique is sizable and fast, with 50 percent of exchange rate variation passing through to prices in less than six months. - The BM has used macroprudential and regulatory tools to support the currency: - Required reserve coefficients were increased on multiple occasions, most recently to 39.0 percent for deposits in local currency and 39.5 percent for deposits in foreign currencies. - The Bank of Mozambique does not remunerate required reserves; the high required reserves ratio therefore acts as a tax on the financial system. - These measures have reduced demand for foreign exchange by lowering liquidity and tightening financial conditions, counteracting pressures for depreciation. ### INDICATORS OF EXCHANGE RATE (DIS)EQUILIBRIUM - Market design and reference rate mechanics - The reference rate has been isolated from volatility because banks submit the previous reference rate as their quote on the centralized platform, resulting in the updated reference rate being equal to the previous one. - A revision to the methodology for calculating the reference rate to include actual transactions is planned for the end of 2024. - This feature is identified as a crucial element in eliminating day-to-day volatility at the current level. - i. Parallel market premium - The parallel FX market in Mozambique is comparatively small and cash based, often described as a “curb market.” - Spreads between official and parallel rates: - From 2018 to 2020, USD/MZN spreads averaged 420 basis points, with the metical trading weaker on the parallel market. - For the same period, ZAR/MZN averaged approximately 80 basis points. - During the period of metical stability starting in mid-2021, the USD/MZN parallel market spread has averaged around 500 basis points. - The parallel market’s limited growth and the absence of large arbitrage opportunities suggest the official exchange rate may not be far from its equilibrium value. - ii. Unfulfilled FX demand & wait time - Market participants can monitor open FX demand via a central platform; no published series exists but two peaks in excess demand coincide with policy changes (2021 tightening and the mid-2023 announcement that the BM would no longer provide FX for fuel imports). - As of October 2024, the banking sector’s approximation suggests around $440 million in unmet demand, excluding dividends. - The primary mechanism to address open demand has been increased wait time for market participants rather than large detachment of the parallel market. - In the second half of 2024, the wait time for an average FX transaction extended to about three months, depending on the type and amount of payments. - Bureaux de change volumes remain low compared to the main market; the parallel market is small but experiencing growth, trading at a premium of about 15% in late 2024. - iii. Net International Reserves and Foreign Currency Supply - Net international reserves recovered substantially in 2023: - USD 3.4 billion by end-December 2023 (or 3.5 months of projected 2023 non-megaproject imports). - Up from USD 2.7 billion at end-December 2022. - The exchange rate remained de facto stabilized against the dollar despite the central bank’s decision to no longer supply FX for fuel imports, indicating FX interventions were not the main cause of sustaining the exchange rate. - Absent other policy measures (such as required-reserve increases), the decision to stop providing FX could potentially have triggered a revaluation. ### DISCUSSION — WHY THE DE FACTO STABILIZED USD/MZN SINCE MID-2021? - Factors working together to create a robust de facto stabilized exchange rate: - Policymaker preferences for low imported inflation: - High real policy rates - High required reserve coefficients - Aftereffects of supervision in early 2021 - Market design with a reference rate that does not reflect actual transaction rates - Importer preferences for a stable FX to increase predictability - Exporter preferences for a stable FX due to US dollar-dominated cost structure - Market frictions (shallow markets and highly concentrated FX supply) that increase risks associated with floating regimes - The combination of these factors has produced resilience to potential shocks (Russia’s invasion of Ukraine, tropical cyclones, monetary policy easing beginning January 2024, and presidential elections). - Transition risks and triggers: - Breakout from the current equilibrium will likely depend on market sentiment, policy action, and changes to market design. - Memories of past supervisory and regulatory events may fade, banks may become less reluctant to adhere to the equilibrium, and monetary policy may become more accommodative in a low-inflation context. - Once the new reference-rate methodology is applied, volatility in transaction rates is expected to be reflected in the reference rate. - Policy guidance for navigating any transition: - Policymakers must carefully manage the transition to minimize disruption and disorderly market conditions. - The BM should closely monitor emerging market pressures and adhere to its intervention policy to counteract disorderly conditions. ### CONCLUSION - The Mozambican FX market does not fit the standard textbook model of a free-floating exchange market despite its de jure floating classification. - Identified drivers of FX stability work collectively rather than individually to establish a de facto fixed exchange rate equilibrium. - Key contributors to stability include policymaker preferences for low imported inflation, importers’ and exporters’ preferences for exchange-rate stability, market frictions (very shallow markets and concentrated FX supply), an unusual daily reference-rate mechanism, and aftereffects of supervision. - Indicators do not show increasing market pressure, suggesting the current exchange rate is not far from its fundamental equilibrium value. - Prospects for a more natural float over the medium to long term: - The proposed new methodology for calculating the reference rate (planned for 2024) will likely translate transaction volatility into reference-rate volatility. - Developments in spot and money markets can reduce shallowness and excessive risk premia. - Improved FX hedging options could reduce exchange rate risks for exporters and importers. - Export diversification could reduce FX supply concentration, facilitating a floating exchange rate with lower risk of disorderly conditions. *Source: Identifying Determinants of FX Stability in Mozambique — IMF Working Paper No. WP/2024/233* --- _Source: https://www.imf.org/-/media/files/publications/wp/2024/english/wpiea2024233-print-pdf.pdf_