‘Capital flow volatility a threat to central banks’

Malawi’s economist at the African Union has said challenges of commodity prices and capital flow volatility pose a serious threat to central banks in Africa.

Dr Maxwell Mkwezalamba, who is Economic Affairs Commissioner at the AU, made the remarks in Algiers, Algeria at the Symposium of the 36th Ordinary Session of the Association of African Central Banks Governors.

In a statement made available to Business News, Mkwezalamba said volatility observed both on the capital and commodity markets continues to be a reality that central bankers have to grapple with in the conduct of monetary and exchange rate policy.

Said Mkwezalamba:  “The difficulty is often with the impact that the movements in these markets can have on [central banks] main objectives, including maintaining low and stable inflation and exchange rate stability. The irony is that these movements are not driven by changes in the macroeconomic fundamentals, while at the same time, they play an important role in [governors] decision making process.

Between 2002 and 2008 there was a substantial surge in commodity prices in the world, including those of fuel and minerals, which had a significant positive impact on incomes and growth in many African countries.

This, Mkwezalamba said, had net private capital inflows to Africa increased significantly in the period before the on-set of the global financial and economic crisis in 2008.

For instance, net private capital inflows to Africa, which are mainly in the form of foreign direct investment (FDI), increased from US$5 billion in 2001 to approximately US$58 billion in 2009, whereas Africa’s share (excluding North Africa) of net capital inflows to developing countries increased from 5 percent in 2007 to 8 percent in 2009. Net portfolio capital inflows to Africa also rose.

But the food crisis of 2008, resulted in rising food prices and food price volatility —exhibited from 2010 —negatively impacted on African economies

“Following the global financial and economic crisis, capital inflows have become very volatile. There were particularly strong flows into equity and bonds in 2010 and an abrupt stop in 2011. Other investment flows also experienced the same volatility with some foreign investors withdrawing from Africa,” he said.

He adds that the volatility in commodity prices and capital flows has had a negative impact on macroeconomic stability, because large foreign currency reserves that African central banks had accumulated prior to the global financial crisis were drawn down in order to supply foreign currency liquidity to local markets to compensate for the withdrawal of foreign private capital.

“In addition, falling commodity prices have resulted in declining terms of trade and worsening trade balances, depreciating exchange rates, and reduced government revenues and gross domestic product (GDP) growth rates for the major commodity exporters,” Mkwezalamba explained.

On the other hand, Mkwezalamba said that during the energy and food crises, many African countries experienced sharp increases in inflation owing to the high weight of food and energy in their consumption baskets.

He says this increase in inflation resulted in real exchange rate appreciation, both in countries with floating and fixed exchange regimes.

“Given that maintaining low and stable inflation and exchange rate stability are among the core monetary and exchange rate policy objectives, the interventions of African central banks are necessary to prevent second round effects of higher commodity prices, including spill-over into inflation expectations and rising wages.

“In view of the fore-going, the need for a policy shift aimed at addressing the detrimental effects of the volatility in commodity prices and capital flows with central banks at the centre of policy prescriptions cannot be over-emphasized,” Mkwezalamba said.