{"id":3614,"date":"2011-07-15T14:03:10","date_gmt":"2011-07-15T14:03:10","guid":{"rendered":"http:\/\/www.faceofmalawi.com\/?p=3614"},"modified":"2011-07-15T14:03:10","modified_gmt":"2011-07-15T14:03:10","slug":"merits-and-demerits-of-depreciated-malawi-kwacha","status":"publish","type":"post","link":"https:\/\/new.faceofmalawi.com\/index.php\/2011\/07\/15\/merits-and-demerits-of-depreciated-malawi-kwacha\/","title":{"rendered":"Merits and demerits of depreciated Malawi kwacha"},"content":{"rendered":"

By Paul Mphwiyo<\/strong><\/p>\n

\"\"LILONGWE \u2013 It is now roughly over one year since our country\u00a0 started encountering economic turbulence: The external position is precarious\u00a0 and our country\u2019s exchange rate policy has once again attracted the attention of\u00a0 those in Washington who are calling for a serious realignment of the kwacha to\u00a0 correct the external imbalance.<\/strong><\/p>\n

The figures that one hears range from 10 to 30\u00a0 percent, but skewing towards the higher end. To borrow the words of Alan Taylor,\u00a0 the irony is that while we have been celebrating our economic successes\u00a0 together, the current problems have been orphans to many people right up to\u00a0 their inception, after which they have become the scions of self-styled\u00a0 commentators who are saying really nothing other than reminding us of the\u00a0 problems.<\/p>\n

While I agree that this has been a tumultuous\u00a0 period, I am deeply concerned that if we focus on the short-run perspective, we\u00a0 risk losing sight of the long term picture. As an economist and a policy-maker\u00a0 who has experience in dealing with the country\u2019s economic programmes, I want to\u00a0 offer arguments on both ends.<\/p>\n

This should be a good precursor to the next episode\u00a0 in which I will offer my preliminary insights on how we may decouple from this\u00a0 debacle and why the zero-deficit budget may be a necessary though painful fiscal\u00a0 adjustment because a monetary adjustment\u2014through a more depreciated exchange\u00a0 rate\u2014was deemed undesirable.<\/p>\n

Exchange rate systems are categorised into three\u00a0 broad categories of flexible (free and managed float); intermediate (peg or\u00a0 basket peg, horizontal band, crawling peg, crawling band) and fixed (currency\u00a0 board, monetary union and dollarisation).<\/p>\n

<p>The International Monetary Fund (IMF) categorises\u00a0 our regime as a managed float but my view is that we have a\u00a0de facto<\/em>\u00a0peg\u00a0 to the US dollar. Among economists, there is consensus that the choice of the\u00a0 exchange rate system to reach monetary policy goals largely depends on the\u00a0 transmission mechanism of monetary policy impulses.<\/p>\n

The argument for currency depreciation is well\u00a0 founded in theory. Firstly, the J-Curve effect suggests that depreciating a\u00a0 currency initially worsens the trade balance and then improves it, thus\u00a0 correcting any prevailing external balance over the medium term. This, however,\u00a0 does not hold for commodity producing countries like Malawi.<\/p>\n

Secondly, the axiomatic \u201cImpossible Trinity\u201d spells\u00a0 conflict between three potentially desirable policies of: (a) A fixed exchange\u00a0 rate (b) Internationally mobile capital and (c) Monetary policy\u00a0 independence.<\/p>\n

For instance, a credible exchange rate peg (item a)\u00a0 means that you will not devalue and in that case interest arbitrage (item b)\u00a0 locks your rate to the base country\u2019s rate, meaning a loss of monetary autonomy\u00a0 (sacrificing item c).<\/p>\n

To break the tight link between the domestic and\u00a0 foreign interest rate (item c) the authorities need to either stop arbitrage\u00a0 through capital controls (sacrificing item b), or else allow the exchange rate\u00a0 to move by going from a peg to a float (sacrificing item a).<\/p>\n

From a theoretical perspective, it is clear how\u00a0 these trade-offs should operate, but from a practical viewpoint, developing\u00a0 countries like ours are even more constrained than this trilemma posits. Fiscal\u00a0 dominance further constrains credible monetary policy.<\/p>\n

Our colleagues in Washington have a snap shot of\u00a0 our economy\u2014a financial programme comprising the real, external, fiscal and\u00a0 monetary sectors. This interdependent system should be showing a clear external\u00a0 imbalance: Driven by an upsurge in both government and private import demand,\u00a0 the current account is negative and worsening.<\/p>\n

Although it sounds unrealistic when authorities are\u00a0 talking, figures show sustained spikes in car imports. It is not difficult to\u00a0 appreciate why the country\u2019s fuel requirements have doubled from about $15\u00a0 million\/month 10 years ago to about $30 million per month recently.<\/p>\n

In addition, there are infrastructure projects\u00a0 going on in the country, not to mention all the residential properties that are\u00a0 being developed\u2014with China as an attractive source of fixtures and fittings.\u00a0 Johannesburg bound aircraft and buses are perennially full of Malawian shoppers\u00a0 and businessmen. The list is endless.<\/p>\n

Monetary accounts consistently show spikes in\u00a0 credit to the private sector but it is all too clear that this credit is not for\u00a0 production but consumption. And on account of past fuel and commodity price\u00a0 shocks, including fertilizers, the fiscus too posted some deficits higher than\u00a0 planned. Simply put, the high growth rates have caused a surge in import demand\u00a0 and the negative terms of trade and price shocks that we suffered amplified this\u00a0 effect, thus overheating the economy.<\/p>\n

IMF\u2019s argument is plausible firstly because a\u00a0 shortage of forex limits the country\u2019s growth prospects by affecting the\u00a0 importation of raw materials for production. Secondly, maintaining a credible\u00a0 peg needs substantial reserves.<\/p>\n

With low international reserves manifested in forex\u00a0 rationing, forex queues\/backlogs and a wide spread between the official and\u00a0 parallel rate, the credibility of an exchange rate peg greatly plummets, further \u00a0subjecting the domestic currency to a speculative attack.<\/p>\n

With low reserves, a speculative attack is\u00a0 difficult to suppress and constraints of the trilemma would entail very limited\u00a0 monetary policy options, the most obvious being currency depreciation. The\u00a0 conjecture here is that a more depreciated kwacha would correct the external\u00a0 imbalance through its effect on tradables and close the large spread between the \u00a0official and parallel rate.<\/p>\n

From a fiscal viewpoint, that would also entail\u00a0 more kwachas from donor inflows, negating the need for a tighter fiscal\u00a0 adjustment. If anyone had provided such an answer in a macroeconomics theory\u00a0 exam, they would get a straight A+.<\/p>\n

But government\u2019s stance is also compelling. First,\u00a0 the argument of dampening import demand is a mere sugar-coating of the fact that\u00a0 a more depreciated kwacha would make our imports more expensive and breed\u00a0 inflation because of high pass-through.<\/p>\n

This is extremely important to a landlocked country\u00a0 like Malawi with high susceptibility to exogenous shocks. It is also not\u00a0 difficult to see that trying to catch up with the parallel rate is like chasing\u00a0 a shadow which will make the exchange rate over-shoot. And with higher\u00a0 inflation, fiscal gains from donor inflows are bound to have a benign real\u00a0 effect. It is almost a zero-sum game.<\/p>\n

These are just the obvious problems; there are many\u00a0 others no less severe. Guillermo Calvo, my macro professor at Columbia\u00a0 University and celebrated author of\u00a0\u2018Fear of Floating\u2019<\/em>would be upset if\u00a0 I did not mention that most developing countries\u2014including Malawi\u2014suffer from\u00a0 \u201cOriginal Sin\u201d in that they are unable to borrow in their own currency on the\u00a0 international market.<\/p>\n

This has substantial balance sheet effects in that\u00a0 large devaluations in the presence of a currency mismatch like we have\u2014where our\u00a0 external assets are less than external liabilities\u2014will have proportionately\u00a0 large valuation effects on our external balance sheet with deleterious effects\u00a0 on output.<\/p>\n

From a global perspective of the international\u00a0 monetary system, my beloved International Macroeconomics Professor, Robert\u00a0 Mundell, Nobel Laureate and Father of Optimal Currency Areas, would clearly\u00a0 prefer a fixed over fluctuating system because the latter is an \u201cexorbitant\u00a0 privilege\u201d that practically transfers seignorage gains to the United States\u00a0 without managing the interdependence of currencies or stabilising\u00a0 prices.<\/p>\n

That is why all major crises happened during the\u00a0 system of fluctuating rates and they are all associated with large swings in\u00a0 major exchange rates. In their best-selling book on the recent financial crisis,\u00a0 \u2018This Time is different\u2019<\/em>, Carmen Reinhart and Kenneth Rogoff corroborate\u00a0 this assertion.<\/p>\n

On the balance of the arguments, it is my view that\u00a0 the local jury returned with a more compelling verdict. The external jury missed\u00a0 crucial evidence in their consideration and they could give us a\u00a0 mistrial.<\/p>\n

We can ask the East Asian Tigers and most emerging\u00a0 economies in Latin America where planned devaluations massively overshot,\u00a0 sending them into economic abyss for some time. And not long ago, a sub-prime\u00a0 mortgage crisis in the US tipped the world into a recession, which has barely\u00a0 abated. The same macroeconomic surveillance experts could not smell anything\u00a0 once again and still remain surprised.<\/p>\n

Going forward, the road will be rough and there are\u00a0 no easy answers. In the short term, donor resources are a matter of necessity\u00a0 because they form a substantial part of our reserves; there must be fiscal\u00a0 restraint augmented by austerity measures; and monetary policy should remain\u00a0 tight, among others.<\/p>\n

Over the medium to long term, we need to start\u00a0 asking ourselves what we have done \u201cto transform Malawi from a predominantly\u00a0 importing and consuming nation to a producing and exporting nation.\u201d<\/p>\n

In the words of John F. Kennedy, we need to start\u00a0 asking ourselves what we have done for our country and not what our country has\u00a0 done for us. Key questions include: What will be the strategic sectors to drive\u00a0 growth? What role can government play? How do we address structural constraints\u00a0 to growth\u2014transport, energy etc? Do we need civil service reform to prepare it\u00a0 for the challenges? We will share our thoughts in the coming series.<\/p>\n

Note: The article was first published in The Nation newspaper<\/strong><\/p>\n

Paul Mphwiyo holds a BA and MA in economics from\u00a0 Chancellor College, an MBA and MA in economic policy and management from\u00a0 Columbia University. He is currently consulting at one of the top international\u00a0 institutions in Washington DC before continuing with further studies in\u00a0 economics. Just before taking his study leave, he was acting director of\u00a0 economic affairs at Malawi\u2019s Ministry of Finance<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"

By Paul Mphwiyo LILONGWE \u2013 It is now roughly over one year since our country\u00a0 started encountering economic turbulence: The […]<\/p>\n","protected":false},"author":1,"featured_media":3615,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[81],"tags":[807,258],"class_list":["post-3614","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-national-news","tag-kwacha","tag-malawi"],"_links":{"self":[{"href":"https:\/\/new.faceofmalawi.com\/index.php\/wp-json\/wp\/v2\/posts\/3614","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/new.faceofmalawi.com\/index.php\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/new.faceofmalawi.com\/index.php\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/new.faceofmalawi.com\/index.php\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/new.faceofmalawi.com\/index.php\/wp-json\/wp\/v2\/comments?post=3614"}],"version-history":[{"count":0,"href":"https:\/\/new.faceofmalawi.com\/index.php\/wp-json\/wp\/v2\/posts\/3614\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/new.faceofmalawi.com\/index.php\/wp-json\/"}],"wp:attachment":[{"href":"https:\/\/new.faceofmalawi.com\/index.php\/wp-json\/wp\/v2\/media?parent=3614"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/new.faceofmalawi.com\/index.php\/wp-json\/wp\/v2\/categories?post=3614"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/new.faceofmalawi.com\/index.php\/wp-json\/wp\/v2\/tags?post=3614"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}