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As smoke gradually settles down on the speculations about the foreign exchange shortage in Papua New Guinea (PNG) this week, we wish to give our readers a sneak preview of the foreign exchange market dating back to 2011 to help our readers understand the current situation.

PNG experienced a decline in foreign exchange between 2011 and 2012. From a peak of 25 percent in mid-2011, the foreign exchange took a sharp nose dive to 9.6 percent in September 2012.

Enough said to intimidate and confuse you. Now what is foreign exchange? The foreign exchange market (forex, FX, or currency market) is a global decentralized market for the trading of currencies. The main participants in this market are the larger international banks. Financial centers around the world function as anchors of trading between a wide range of multiple types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies, in our case, the PNG kina.

In PNG, Bank of PNG as the regulator of banking systems regulates the foreign exchange market, with the foreign exchange market performance determined surely by the market sentiments.

In the simplest terms, the foreign exchange reserves appear as net foreign assets on the central bank’s balance sheet, balancing out the liability for the central bank of the increase in Kina in circulation (there are nuances to this, for example, the foreign exchange is to buy Kina to pay royalties and taxes to the government and the government holds these payments in its accounts at BPNG).

The growth in foreign exchange reserves was the main driver of growth in the money supply in 2010 and 2011 through the increase in net foreign assets, and, as the central bank’s foreign exchange reserves decline, its net foreign assets have fallen (by 4.3 percent in the year to the end of September 2012), slowing growth in the money supply from a peak of 25 percent in the year to December 2011 to 9.6 percent in the year to September 2012.

Our kina has since picked up 18 percent growth after shedding one-third of its value since 2013. On Wednesday this week, introduced an exchange rate trading band in foreign exchange market this week and we quote the central bank governor Loi Bakani;

Effective as of Wednesday 4, June 2014, an exchange rate trading band of 150 basis points; that is, 75 basis points above and 75 basis points below the official in inter-bank rate is set within an authorized foreign exchange dealer can trade currency”

Why was there are need for the central bank intervention?

The first reason central banks intervene is to stabilize fluctuations in the exchange rate. International trade and investment decisions are much more difficult to make if the exchange rate value is changing rapidly. Whether a trade deal or international investment is good or bad often depends on the value of the exchange rate that will prevail at some point in the future.

The second reason central banks intervene is to reverse the growth in the country’s trade deficit. Trade deficits (or current account deficits) can rise rapidly if a country’s exchange rate appreciates significantly. A higher currency value will make foreign goods and services (G&S) relatively cheaper, stimulating imports, while domestic goods will seem relatively more expensive to foreigners, thus reducing exports. This means a rising currency value can lead to a rising trade deficit. If that trade deficit is viewed as a problem for the economy, the central bank may be pressured to intervene to reduce the value of the currency in the Forex market and thereby reverse the rising trade deficit.

Now we are confident that we have given you a sneak preview of the foreign exchange market performance dating back to 2011. We have also given you the reason why it is important for the central bank to intervene in such a situation.