Devaluation: A bold reform made too late?

The year 2023 has been tough for local traders and consumers alike.

First, there were long queues at filling stations after fuel pumps ran dry. Then there was the shortage of cement. At the heart of all these problems was the perpetual scarcity of foreign exchange that had rendered exporters incapable of importing.

The economy was in free-fall since the start of this year. The kwacha’s loss in value against major currencies was fast eroding the gains made by 25 percent kwacha devaluationeffected by the Reserve Bank of Malawi (RBM) in May 2022.

By June 2023, the Economist Intelligence Unit (EIU), a research and analysis division of the United Kingdom-based Economist Group, predicted that the Malawi Government would devalue the kwacha on account of the foreign currency shortages, which it said were making imports of food and fuel more expensive.

In its June 2023 issue of the Malawi country report, the EIU said it expected the RBM to devalue the local unit by 20 percent although it conceded that their prediction was “fairly conservative”. The kwacha had already fallen much further than that.

At this time, the kwacha was trading at an average of K1 550 against the dollar in authorised dealer banks (ADBs). This was against K1 036 daily foreign exchange bureau rates published by the RBM, creating a spread of about K514 or 49 percent.

Gross official reserves, the amount of forex under the direct control of the central bank, had dropped to $194.82 million (about K330 billion or 0.78  months of import cover at the end of May.

According to the World Bank, this was one of the lowest foreign exchange reserves in the five-year period since 2021.

The growing spread between the price offered by ADBs and the forex bureau rates prescribed by the banks coupled with the fuel shortages that followed the perpetual forex shortages, sparked a fierce debate among economic experts on whether the Malawi Government should devalue the kwacha.

Economics Association of Malawi president Betchani Tchereni, who is also associate professor of economics at the Malawi University of Business and Applied Sciences, urged the government to devalue the kwacha because the local unit had “already lost its value”.

He further said keeping an overvalued exchange rate would hurt local exporters, particularly in the agricultural sector, because they would be selling their products at a lower rate, but importing raw materials at a higher price.

Agreeing with Tchereni, LM Aquaculture managing director David Nkhwazi, whose firm is in export business, said the spread between the official rate and the rate offered by commercial banks was hurting local exporters such as him.

Said Nkhwazi: “Exporters sell the proceeds from their businesses using the surrender requirement at a lower rate [K1 060, but pay for freight fees with Iata [International Air Transport Association] at a higher exchange rate of more than K1 500.  We are losing money when exchanging the forex.”

Local exporters are legally required to sell 30 percent of their forex to ADBs through the surrender requirement imposed by the central bank.

In a separate interview, economic analyst Bond Mtembezeka had a different view.

He said devaluing the kwacha would have a negative impact on the local economy considering that Malawi is a net importer.

Said Mtembezeka: “As imports become more expensive due to a devalued currency, the local population’s purchasing power decreases, leading to a rapid upward trajectory in poverty levels which compromises living standards of the local population.”

On the prospects of devaluing, Mzuzu University economist Christopher Mbukwa argued that devaluation will “have zero effect on treating negative trade balances and forex shortages in the country”.

He said: “As such, it would be prudent to find structural solutions to boosting our trade balance rather than devaluing the kwacha as it would exert dire inflationary pressures on the economy.”

The central bank would then bow down to pressure from global financial institutions.

RBM devalued the kwacha by 44 percent effective November 9, in anticipation of the upcoming Extended Credit Facility with the International Monetary Fund (IMF), which would unlock donor funding and provide Malawi with forex injection from other bilateral donors.

Soon after the devaluation, the IMF approved the $175 million four-year ECF, which eventually unlocked dollar injection from bilateral donor.

However, the d evaluation triggered inflationary pressures, prompting local employee groups such as the Malawi Congress of Trade Union to call for a 44 percent salary increment. The negotiation and protests are ongoing.

However, the devaluation showed the donor community that Malawi was serious about taking bold economic reforms to restore macroeconomic stability.

The donors duly released the much-needed forex. The course correction in the economy is palpable.

But the sense of “what if” remains. How further along would Malawi be if the government had been bold enough to devalue the local unit in June or July, when there were clear signs that the kwacha was grossly “overvalued”.