Currency board administration in Malawi

 The Malawi economy is currently facing a debt crisis. Many factors have converged to exacerbate the situation such as Covid-19 pandemic and war in Ukraine.

However, the economic fragility was there even before these crises. Ever since Malawi suffered its first balance of payment dislocation that led to the first International Monetary Fund (IMF) intervention in 1979, the country has never recovered or been able to graduate from the IMF support programmes. Since independence, Malawi has used discretionary monetary policy. This policy has not been able to resolve the worsening of the twin deficits, neither primary nor secondary over the years it has been in operation in Malawi.

This report recommends the use of Currency Board Arrangement (CBA) monetary policy rather than continuing to struggle to reform the existing discretionary policy. Using the currency board administration, the Malawi kwacha will be pegged at a fixed exchange rate against an anchor currency, presumably the US dollar.

The anchor currency does not have to be the US dollar. It could be the South African Rand, British Pound Sterling or the Euro. Several factors will be considered when making this choice.

Many countries facing economic crises of the worst kind have adopted the currency board policy to achieve economic stability and growth. For example, since independence, Namibia successfully anchored its currency against the South African rand. Other examples include Singapore, Russia, Estonia and Bulgaria.

Malawi faces a stark existential choice. Either continue with the current monetary policy that has not worked for 58 years or adopt a new monetary policy, CBA. The recent IMF article IV report has highlighted profound structural dislocations within the Malawi monetary and fiscal policies.

The report states that public debt and external debt have both reached unsustainably risky levels and that the current pace of adjustments of one percent of gross domestic product cannot fix this worsening economic situation.

The report recommends immediate reforms in public financial management to contain the ever-widening fiscal deficit and debt. The IMF does not believe the current discretionary monetary policy can address this required profound change. Instead, they recommend that Malawi seeks non-debt capital inflows from development partners.

The problem with using non-debt inflows by itself is that it will only be a short-term, band-aid solution. Malawi cannot continue going around the world with a begging bowl for financial help. The country needs a permanent solution that will lead to self-sufficiency and will address the chronic shortage of foreign exchange and low foreign reserves.

The CBA is a proven monetary policy that can address these economic challenges immediately and permanently, including tackling both the monetary policy discipline as well as curtailing government wastage and deficits.

What is a currency board?

A currency board is where a currency is backed either 50 percent or 100 percent by an anchor foreign currency such as the dollar, British pound or Euro at a fixed exchange rate.

Management of the exchange rate and the money supply are taken away from the traditional central banking and handled by the CBA separately or within the central bank. In addition to maintaining a fixed exchange rate, a currency board is also required to manage foreign reserves of the underlying anchor foreign currency such as the dollar.

How will currency board work?

Under the CBA system, the management of the exchange rate and money supply will be given to a new monetary authority department that will make decisions about the valuation of the kwacha. This monetary authority will be under legal instructions to back all units of the kwacha in circulation with the chosen foreign anchor currency.

During implementation, a decision will be made whether to back 100 percent of the kwacha units issued. The CBA will allow for unlimited exchange of the kwacha for the anchor currency such as dollar, British pound and Euro. For example, today the Reserve Bank of Malawi (RBM) prints money at will, but a currency board must back additional units of kwacha issued with foreign anchor currency.

This leads to accumulation of foreign currency reserves. The CBA will invest these reserves in foreign securities to earn interest in the foreign currency. As a result of this, domestic interest rates will tend to mimic the prevailing interest rates in the anchor foreign currency country.

To illustrate this point, if the anchor currency is in dollars, then Malawi interest rates will tend to converge to the US interest rates levels. CBAs operate under strict rules enshrined in law. Those managing the CBA will be fully trained on all processes, procedures and the law.

Not only will such an approach provide an unequivocal signpost of good decision-making, but it will also act to protect office bearers from political pressures to finance deficits. The CBA will not be allowed to provide credit to the government or to commercial banks. This will act as an automatic regulator of limiting government deficits in line with what the IMF is also recommending for the government to bring its domestic and external debt under control. Government expenditure must be in line with its income revenue. In order to be transparent and accountable, the CBA will publish its balance sheet, say weekly or whatever frequency, that will be determined on the outset. With increased transparency and stable monetary policy, foreign direct investment (FDI) to Malawi will increase.

With the introduction of the CBA, Malawi will no longer be under the IMF programmes. Since the kwacha will enjoy full convertibility, foreign savers will bring their money to deposit in Malawi commercial banks to take full advantage of arbitrage. Given that the kwacha exchange rate to the dollar will be fixed, the CBA will be instructed to issue and redeem the kwacha in the economy without any restrictions.

What are advantages of the CBA system?

CBA regime will bring economic stability to Malawi because it is rule-based in nature. It will offer stable exchange rates that will promote trade and investment in Malawi. The discipline of not printing money to finance government deficits will restrict government actions to help tackle government wasteful or irresponsible practices.

The CBA will keep inflation low, stable and predictable. It will keep interest rates low. CBA will encourage industrialisation in Malawi because initially investors will be able to import machinery for manufacturing without facing forex shortage or risk of devaluation. The increased investment has the potential to create millions of jobs and to spur rapid economic growth.

CBA will improve Malawi’s external balance because of (i) increased influx of foreign savings (ii) increased FDI (iii) interest rates earned on accumulating foreign reserves and (iv) reduced import levels due to government non-deficit spending restrictions.

What are the main implementation steps?

Implementation will follow a step-by-step process. An implementation team will be assembled, comprising members from RBM, Ministry of Finance and Economic Affairs and Ministry of Justice. These will work through an implementation methodology framework to address key required decisions.

Below is a snapshot list of typical questions to be addressed:

l What must be the level of pegging, 50 percent or 100 percent, of all the kwacha issued and why? Which currency to peg against and why? What will be the fixed rate? Here we must consider contingency and outlook.

What will be backed, notes in circulation only or include bank deposits as well and why? What is the value of reserves in Malawi? Can we convert them to the required reserve currency?

Can we sell gold reserves to raise the required CBA reserves or not? As Malawi is under IMF programme, how will IMF loans be handled? How about any other outstanding loans? How must they be handled?

Experience around the world has shown that the IMF and the World Bank are supportive of countries establishing currency boards.

Assuming there are about K400 billion notes in circulation and at a fixed exchange rate of $1 to K1 021, then Malawi will need $392 million. Add 10 percent contingency on top of that just in case, then Malawi will need $431 million to back the kwacha for example. CBA will charge a small commission on transactions.

What are the legal considerations?

CBA rules and procedures, including the fixed exchange rate must be enshrined in Malawi law so that CBA managers cannot take shortcuts to bypass the correct expected processes and procedures, no more discretion. The legal team will put into law the CBA charter, organisation structure, office bearers and other details.

Printing unlimited money to finance the government deficit will not be allowed and the law will clearly stipulate that. Government must operate within income revenues or borrow using securities such as Treasury bills or bonds.

CBA will not be allowed to act as bank of last resort for commercial banks. This facility must be accommodated outside the CBA if required. Banks will rely on the interbank lending market and external sources to borrow additional capital.

The CBA will also not carry out commercial bank supervision function. This function must be done by the Banking Supervision Department of RBM. CBA will no longer set interest rates in Malawi removing the current bank rate set by the Monetary Policy Committee.

Commercial banks will set their own interest rates on deposits and loans without the bank rate reference. n

*Thomas Ngoma is a United Kingdom-based executive management consultant with over 35 years’ experience advising clients on strategic business transformation both in public and private sector.