Banking sector liquidity crisis exacerbated by Kwanza agreement

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The Bank of Namibia recently released figures showing that it currently has approximately N$2.8 billion worth of Angolan Kwanza in its bank account, following the agreement between Banco Nacional De Angola and the Bank of Namibia, which allowed for the direct exchange between the Kwanza and Namibia Dollar at banks and bureaus de change in Namibia.
This agreement came into force in late June and resulted in way more activity than anyone anticipated, particularly at Oshikango. The idea behind the agreement was that it would enable Angolans to come over the border and buy goods in Namibia, using Kwanza, which they could convert at the local banks and bureaus de change.
The idea was simple – Namibia converts Kwanza into Namibia Dollars; those Namibia Dollars are spent in Oshikango (and elsewhere) in exchange for goods and services, meaning the Namibia Dollars remain in the country, as do the Kwanza.
Thus Namibia keeps the Namibia Dollars and gets the Kwanza, in exchange for the aforementioned goods and services. Later, the Kwanza is exchanged back into US Dollars by Banco Nacional De Angola.
However, while some of this activity was seen, eyewitness accounts talk of Angolans crossing the border with – quite literally – bakkie-loads of cash, which they then exchange into Namibia Dollars. Rather than spending this money in Namibia, much of it was taken back into Angola.
The reason for this is simple: Angolan’s trust the value of the Namibia Dollar more than the Kwanza. The flurry of currency exchanging activity at the border during the first few weeks of trading was so extreme that many of the local banks had to close their branches, as they simply couldn’t deal with the demand for Namibia Dollars from Angolans with Kwanza.
At the same time, the price of oil, Angola’s primary (almost only) source of hard currency earnings, fell through the floor, declining by approximately 50% between June 2014 and June 2015. This has meant that the Banco Nacional De Angola is unlikely to have sufficient hard currency (US Dollars) to exchange for the N$2.8 billion worth of Kwanza currently sitting in Namibia.
Assuming little trade in Kwanza for goods or services in Namibia, the numbers recently released by BON suggest there is close to N$2.8 billion worth of Namibia Dollar notes currently in Angola. While the number is unlikely to be quite this high, it appears that a huge amount of Namibia’s actual cash money is sitting in Angola.
As of the end of August, Namibia has N$4.26 billion in hard currency in circulation, meaning the said N$2.8 billion would represent 66% of all of Namibia’s cash!
Given that the multiplier effect on this cash money to base money is usually 12 to 24x, the net outflow is absolutely vast in terms of the effective base money withdrawal. Consider how many times a N$10 dollar note changes hands in a year and how much that note buys, to get an idea of the multiplier.
Now remove that note from circulation and put it in Angola, and you

get a simple illustration of the problem. Not only will this have a devastating impact on the hard currency (external) position of the country until the Kwanza is exchanged into US Dollars (which could be anytime, and unfortunately, Kwanza is no hard currency!), but it is also very likely the proximate cause of the current banking sector liquidity crisis in Namibia.
We must note, of course, that there is a distinction between banking sector liquidity and prudent asset allocation decisions by pension fund asset managers (as is their legal, fiduciary, duty). The former and latter have little to do with one another, other than the fact that they both have an impact on demand for government debt securities, used to fund the budget deficit.
Interestingly, this Kwanza development (release of information) comes at the same time as Namibia is scrambling to raise a hard-currency Eurobond to protect the country’s external position. While there is no doubt a great need for this, it must be said that it was avoidable.
Namibia, as part of the common monetary area must meet a clause that stipulates that Namibia must hold sufficient hard currency reserves to cover currency in circulation. The logic – to ensure that if all (or a lot) of the Namibia Dollar cash money ends up in the vault of the South African Reserve Bank (SARB) Namibia will be able to “buy” back the Namibia Dollars, by giving the SARB a currency they can use, given that the Namibia Dollar has no value in South Africa, as the Kwanza has no value in Namibia.
It should be noted, in addition, that the focus exclusively on currency in circulation, relative to international reserves, is fatally flawed. Covering currency in circulation is just one of many uses or needs for hard currency. There are a vast number of others, which is the primary reason that the IMF advocates three months’ of import coverage of reserves, more than twice as much as Namibia currently has.
Further, despite claims to the contrary, the repatriation of the Kwanza will do little to bolster the external position, unless the money is kept in hard currency. This may happen. However, it keeps the funds out of the banking sector – unless BON prints more money, which will be inflationary and will simply exacerbate the liquidity crisis.
Peculiarly, while the primary mandate of the Bank of Namibia is to protect the country’s external position, it has pursued a policy of historically low interest rates through a period of abnormally high growth.
This certainly helped to drive growth in consumer credit demand, which resulted in major increases in imports funded by domestic money – thus a net outflow of Namibian money and a decline in reserves.
Now, the bank is hiking into economic weakness, while the Ministry of Finance fights to protect the external position with external bond issuances.
With regards to the funding position of government, much of the current liquidity crisis has been driven by loose monetary and fiscal policy.
However, the major withdrawal in hard currency from the Namibian economy is likely to be the primary and underlying cause of the current liquidity crisis and lack of demand by banks for government securities at recent debt auctions. It is also likely to be the underlying reason for the slowdown in credit extension to households by many of the commercial banks.

* Rowland Brown is the head of research at IJG Securities. This article is published with his expressed permission.

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