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2012 Year ender: Taking stock of devaluation impact

Devaluation and flotation of the kwacha was one of the bold decisions President Joyce Banda made in her effort to resuscitate the economy. But are Banda’s economic reforms working? Our News Analyst CHIKONDI CHIYEMBEKEZA writes about this and other issues:

Late president Bingu wa Mutharika vehemently opposed the devaluation of the kwacha. In one of his many speeches against the loosening of the local currency early this year, late Mutharika lost his cool and lashed out at the Western donors and other proponents of devaluation.

“They are just arrogant, undermining what a black man can do. They think because they are westerners they know everything. Devaluation is not a panacea to Malawi’s economic problems,” he argued.

This was in the midst of Malawi’s economic turmoil. The country was battling with severe fuel and foreign exchange shortages and struggling industries.

The kwacha was officially fixed at K165 to $1—against a parallel market rate of over K200.

Local economists and the Malawi Confederation of Chambers of Commerce and Industry (MCCCI) said the kwacha needed to be devalued to bring it in line with the thriving parallel market.

The need to devalue the kwacha was part of IMF conditionality that would enable Malawi to win back the country’s three-year Extended Credit Facility (ECF) arrangement, which the IMF had suspended mid 2011 over what they called failure by the Government of Malawi to adhere to conditions attached to the fund.

The country’s commercial banks were then trading the kwacha at an official rate of K165 to a dollar while on the parallel market, the currency was trading at around K300, a development that brought about acute shortage of foreign exchange on the formal market, negatively affecting business operations in the process.

Forex shortages

Proponents of the devaluation argued that it would provide support to exporters, easing the foreign exchange shortages.

But Mutharika outrightly rejected this argument, observing that devaluation would lead to lower living standards, rising cost of living and industrial actions because workers would want their perks to be increased in line with the value of the local currency.

At a time the situation was biting, Mutharika stated that he needed three years to sort out the economic mess, instead of just asking him to devalue the currency.

He said he wanted to be given space to tackle the economic problems.

“If donors are going to criticise that, saying this is not democracy, to hell with you. If any donor wants to withdraw from this country, let them leave and go.”

He added: “I can assure that I can fix the forex (foreign exchange) problem on my own if the IMF can leave me alone and let me employ my policies without disturbing me. I can fix the forex problems in 12 months.”

Some Malawians were, however, not amused with late Mutharika’s utterances and did not believe that he had the knack to sort out the economic crisis without donor support, particularly because aid accounts for about 40 percent of the country’s national budget.

The IMF was also not amused with Malawi’s overvalued exchange rate as stated in their December 2011 report titled ‘Liberalisation of the Foreign Exchange Regime for Current Account Transactions and Exchange Rate Flexibility’, issued after their fact-finding mission on Malawi’s economic management.

The global lender mission had observed that Malawi’s overvalued exchange rate was causing persistent imbalance on the exchange rate market.

“An overvalued exchange rate has in turn led to foreign-exchange market rationing and multiple exchange rates, which remain key deterrents to private sector activity, growth and diversification,” reads the report in part.

Aid flows

The report had also cited the reduced aid flows and an exceptionally poor tobacco market as some of the issues that had exacerbated the acute shortage of foreign exchange in the country.

As fate would have it, Mutharika died in early April and then Vice-President, Joyce Banda, assumed the reins of power.

Fast forward to May 7 2012, the Reserve Bank of Malawi (RBM) boldly announced the devaluation of the kwacha by about 49 percent and subsequently adopted a free-floating exchange rate regime, a move analysts predicted will likely have negative effects on firms and macro-economic variables.

The business community argued it would be a boon for exporters and also result in more foreign exchange being available in the banks.

The devalution resulted in the kwacha falling to K250 against one US dollar from the previous K165.

RBM’s move came against the background of complaints by the business community and money market players, among others, that the kwacha was heavily overvalued with the black market rate trading at about K300 to one US dollar against the official rate of K167.

The overvalued local currency, which resulted in forex shortages, had been a major contributor to the rising liquidity levels over the past few weeks which hit K12 billion in late March because foreign companies failed to remit the proceeds.

Money market analysts argued then that there was need for reasonable inflows of foreign exchange reserves to settle the huge backlog of foreign bills.

Government’s reluctance to devalue the currency for some time had resulted in unofficial black market prices being increasingly passed on to consumers as inflation was on the upward spiral.

Monetary policy

But assessing the impact of the monetary policy move seven months on, commentators have given mixed views.

“The devaluation of the kwacha has caused prices of goods and services to become more expensive, worsening the inflationary environment.

It has also put a strain on profits of importing companies and also on the wider economy,” said an investment advisory firm Nico Asset Managers Limited in its latest economic review.

The firm said a flexible exchange rate regime poses a challenge to businesses in planning for expenditures due to the volatile operating environment.

“A weakening currency increases external liabilities for companies that have foreign currency liabilities on their balance sheet,” said Nico Asset Managers Limited.

The weakening currency has resulted in soaring inflation reducing disposable income thereby increasing the cost of capital as authorities increase interest rates to contain rising inflation.

Already, inflation is on the rise, with the November rate hitting 33.3 percent from 30.6 percent, according to the National Statistical Office (NSO).

With the rising inflation, RBM has been under pressure and has increased the bank rate three times since April to rein in on rising inflation which has found a comfort zone in the double digits since early this year.

Surging bank rate

The bank rate is currently at 25 percent.

On his part, University of Livingstonia economics lecturer Dr. Colleen Kaluwa in an interview said Malawians should brace for tougher times ahead.

“Fuel cost will go UP due to the exchange rate regime which will result in transportation cost going up as well,” he said, adding that generally, devaluation is mostly good for countries whose economies are export oriented, citing Japan.

But Kaluwa noted that Malawian companies that export their goods have benefited from the easing of the kwacha rate because their goods are competitive on the international market.

“This means that these companies will be exporting cheaply,” he said.

On the positive side, demand for stocks on the local bourse from foreign buyers has soared because of the devaluation which has made shares on the Malawi Stock Exchange (MSE) to be cheaper in real terms, according to stockbrokers.

“Combined with demand from local institutional clients seeking a store of value, especially as inflation edges up, this demand could lead to firmer prices in the medium term,” said a market analyst.

But economist Alick Nyasulu observes that it would be sheer arrogance to expect the devaluation to solve all the country’s problems faced by a typical household on a daily basis.

“Our issues have never been a monetary policy juggernaut, but supply side. Sometimes economics and its policy crafting should depart from the theory juggernaut of fiscal and monetary archaic tradition,” he said.

He said the average Malawian household has no job, lives in the village and often depends on subsistence farming; hence, devaluation or not, they will continue to farm and sell bits of that surplus to fellow subsistence farmers and life goes on.

“While devaluation is a fashionable monetary policy tool, our ability to move forward our country remains in job creation, quality education for all kids and a war on corruption,” said Nyasulu.

It remains to be seen if Malawians will fully benefit from the devaluation of the kwacha in the medium to long term.