Sierra Leone-Freetown: The Leone in 2020 was relatively stable against the US dollar, depreciating by 4.4 percent (year-on-year [yoy]) compared to 15.3 percent in 2019, which means it has a 10.9 improvement in its valuation.
Compared to 2017–19, the World Bank Sierra Leone Economic Update said that the exchange rate depreciation moderated considerably, supported by lower import demand, Bank of Sierra Leone (BSL) interventions to facilitate the import of essential commodities (food and fuel), and administrative measures to limit uncertainty and prevent market pressures from destabilizing the already-thin market.
The Update also indicated that, a relatively stable exchange rate has been crucial in moderating inflation, which otherwise would likely have gone higher and had an evenly larger negative impact on the welfare of households.
“The premium between the official and parallel market exchange rates from 3.8 percent in December 2019 widened to 5.7 percent (yoy) as restrictions imposed by the BSL in 2019/20 pushed foreign exchange (forex) transactions to the parallel market, reflecting difficulty in obtaining forex from official channels (banks and forex bureaus).”
Responding to parallel market pressures on the exchange rate, the BSL banned street trading of forex, with stiff penalties for violations of the ban. The ban followed two directives in March 2020, one restricting offshore trading of forex by non-governmental organizations, and the other prohibiting both foreign currency-denominated contracts and transfers between foreign currency accounts.
The capped forex accounts at US$10,000 by BSL was lifted in December 2020 when banks experienced cash shortages due to unexpected demand. BSL suspected that high parallel market premiums could be diverting transactions to the parallel market and starving the banking system of needed cash.
However, between December 2019 and December 2020 the yoy cash holdings of banks remained stable, which suggests that the cash shortage in December 2020 was a cyclical event.
The exchange rate was relatively stable in the first quarter (Q1) of 2021, depreciating by 4.8 percent (yoy) in March 2021 as imports remained subdued. The premium between official and parallel market exchange rates narrowed to 1.2 percent as bank forex transactions increased after the BSL removed some restrictions.
Sierra Leone’s real effective exchange rate (REER) has appreciated in recent years as high inflation outpaced nominal depreciation. The nominal effective exchange rate has depreciated in recent years but was relatively stable during 2020.
The IMF (2020) estimates that the country’s REER is overvalued by 20–30 percent under certain assumptions, such as interest differentials between external assets and liabilities, the exchange rate adjustment affecting both net exports and the net international investment position, and comparing debt discounted for the future compared to its level today.
The overvaluation is consistent with historic high Current Account Deficit (CADs) and reflects the considerable appreciation of the leone to the US dollar in real terms in recent years, as inflation outpaced nominal depreciation.
To reduce the REER overvaluation and improve competitiveness, the Bank advised that the country should undertake a robust mix of structural reforms focused on identifying new export markets, improving the business environment, increasing productivity, and boosting competitiveness.
ZIJ/9/8/2021