The local currency, kwacha, is expected to weaken further against major trading currencies on account of a flexible exchange rate regime, Nico Asset Managers have said in their monthly economic report for August 2012.
A flexible exchange rate regime adopted on May 7 when the local unit was devalued by nearly 50 percent and floated, requires enough foreign currency reserves to support it.
The investment advisory firm has attributed the weak foreign currency buffer to a 40 percent drop in revenue for tobacco, Malawiâ€™s principal export crop which brings in about 60 percent of the countryâ€™s foreign currency earnings.
This year, tobacco raked in $177.8 million, an equivalent of 1.37 months of import cover, from last yearâ€™s $293 million on account of low output amounting to 78.8 million kilogrammes (kg) from a record 237 million kg.
â€œTherefore, the kwacha may weaken following the close of the tobacco season. With fertiliser imports soon to begin, further strain on forex reserves is expected. The economyâ€™s dependence on foreign aid in ensuring adequate reserves will be higher,â€ says the firm.
Normally between September and February, it is traditionally a lean period for foreign exchange earnings for the country coming after the closure of tobacco sales.
The firm says with International Monetary Fundâ€™s (IMF) Extended Credit Facility (ECF), the exchange rate could be relatively supported given the support other donors such as World Bank and African Development Bank (AfDB) are offering.
But National Bank of Malawi (NBM), in its monthly newsletter for September 2012 released this week, said the pressure on the currency has been compounded by late resumption of the IMF programme which essentially has resulted in most bilateral donors not participating in aid disbursements in the first fiscal quarter (July- Sept).
NBM agrees with Nico Asset Managers that pressure on the local currency is expected to continue as the country begins importation of crucial commodities such as fertiliser and other agricultural inputs against weak earnings.
NBM said the black market has since resurfaced and could get worse if the supply side does not improve.
It said although bilateral aid is expected to pick up in the second fiscal quarter, part of the aid may be delayed in the wake of the audit scandal at the National Audit Office (NAO) and failure to resolve the issue of minority rights, in particular, the decriminalisation of homosexuality.
Nico Asset Managers has said the timing of the donor inflows remains key to the stabilisation of the kwacha.
According to the Reserve Bank of Malawi (RBM), total foreign exchange reserves as at August 30 2012 stood at $405 million, an equivalent of 3.14 months worth of import cover compared to $312 million, an equivalent of 2.42 months worth of import cover at the end of July 2012
Of the total reserves, $180 million was sitting with the RBM and the private sector reserves have remained above the official reserves, reflecting the policy change of tobacco dollars going directly to commercial banks as directed by the central bank in May.
Nico Asset Manager says the kwacha continued to weaken in August, recording a depreciation of 1.1 percent against the US dollar to K281, 0.6 percent against the pound sterling to K443.56 and 2.4 percent against the euro to K351.42.
However, the local unit strengthened against the South Africa rand by 6.4 percent to K33.15.
The firm says the flexible exchange regime is not without problems.
â€œA flexible exchange rate regime poses a challenge to businesses in planning for expenditures due to the volatile operating environment. On the upside, a flexible exchange rate has improved the availability of forex which enables the importation of items such as fuel, fertiliser, medicines and other materials,â€ says the firm.
Forex availability improves investorsâ€™ confidence in the market as foreign investors are more positive about their ability to convert investment returns to foreign currency, thereby providing new foreign direct and portfolio investments into the country, according to Nico Asset Managers.
But this could happen with a lag as the economy is still recovering, it said.
A weakening currency, on the other hand, could result in improved prices for local exporters. On the downside, servicing foreign currency denominated loans will become more costly.