Devaluation, central banks

The ides of March have come and I am still alive,” says Julius Caesar in Shakespeare’s play known by that name.

“Yes, they have come, but they have not yet gone,” replied Spurinna.

The same can be said about the devaluation of the kwacha the Reserve Bank of Malawi (RNM) Governor Charles Chuka announced on May 7 2012.

Some people looked with forebodings to the day when the kwacha would be devalued.

They thought it would be a day of fire, brimstone and of gnashing teeth. Contrary to their expectations, May 7 came and went with business as usual.

But does that mean there was nothing to worry about?

Good or bad

Of course, not! The devaluation will have consequences both good and bad.

What necessitates the devaluation of a currency?

Usually, it is the trend of that country’s exports and imports.

Though we use money to pay for our exports, in the final analysis, we exchange exports with imports.

If exports of a country are increasing, the value of its currency goes up. But if exports are declining, imports increase, hence; the value of that country’s currency goes down.

This happens when a country’s exchange rate is free floating or subject to market forces of demand and supply.

The Malawi currency exchange rate was fixed vis-a-vis the dollar. It could only be varied by official fiat.

Though our exports had been declining over the past three years or so, the exchange rate remained intact.

It did not reflect the realities of our exports performance.

This is what economists and donors meant when they said the kwacha was overvalued.

There are times in life when one must take a drastic action to prevent a situation from deteriorating to the point of no return. As such, we amputate a cancerous leg to save the life of the patient.

RBM and the new administration must be congratulated for being bold and honest enough to do what could no longer be postponed and to accept the challenge that might follow.

Release aid

Since devaluation was one of the conditionalities the International Monetary Fund (IMF) and donors set to release aid to Malawi, let us hope that our development partners will respond on time.

Devaluation has its own thistles and scorpions like those of Mount Sinai. We do not want an ordinary Malawian to remember with nostalgia the days he was in Pharaoh’s Egypt and say did our new President comply with external pressure to devalue the kwacha to bring upon us all these hardships?

If the people can see the forex and petroleum problems eased, they may shoulder with equanimity the other hardships such as creeping inflation.

As stated earlier, devaluation is meant to solve the imbalance between imports and exports. When a currency is devalued, the country’s products become cheaper on foreign markets and in foreign currencies.

Elementary economics teaches us that when the price of a commodity on the market falls more of it will be bought.

Our hope is that Malawi’s exports both agricultural and manufactured will become more competitive on the global market. But will they?

Whether they will become more competitive will depend on the reaction of our competitors to the news that Malawi has devalued its currency by almost 50 percent.

Devaluation may be likened to reduction of prices in a shop. When one shopkeeper puts a ‘sale’ placard in front of his shop, the other shopkeepers may either do nothing about it or reduce their prices too.

If the competitors do not reduce their prices, those who have reduced theirs can obtain increased traffic into their shops and boost their sales.

If their competitors also reduce theirs, then the level of competition is back to square one.

Extra exports

Devaluation of the kwacha can result in extra export sales if price was the main deterrent to sales. That is, if people abroad were shunning our exports because they were too expensive. If the foreign buyers were shunning our exports because their quality was not appealing to the buyers, sales may not increase.

The devaluation will boost sales depending on supply elasticity. Following the devalued kwacha (and, therefore, reduced prices) can we now put on the foreign market more of our products?

We have crops we sale outside the country for forex. But for crops such as tea and coffee, the gestation period is five years, more or less.

In the latter case, the beneficial results of devaluation may take time.

The aim of devaluation is also to discourage importation of goods which we are making or we can make and, therefore, economise on foreign reserves.

—To be continued on Monday