Last week, we discussed the first effect of devaluation which is causing effects to be expensive.
As we continue tackling the topic of devaluation, let us think about a farmer, Bulabula, who grows and sells tobacco. If he sells tobacco at $1 per kilogramme this year, then he will be getting K150 per kilogramme (K150 multiplied by $1). Now with the currency devaluing from K150 to K200, Bulabula will be getting K200 per kilogramme (K200 multiplied by $1).
So the farmer, Bulabula, is getting more Kwachas even though the value in dollar terms is the same. The devaluation is helping the farmer to earn more. This will motivate Bulabula and other friends who did not grow tobacco this season to grow more tobacco next season.
The second effect of devaluation, therefore, is boosting income for exporters and incentivising them to export more. This would subsequently bring in more dollars into the country.
However, whether Bulabula could reap the full benefits of the devaluation could partially depend on whether he buys local or imported goods. This is because imported materials, like OweheryaÃ¢â‚¬â„¢s car, will now have become expensive due to the devaluation and importers are likely to increase prices of their imported goods.
Assuming that most of the goods in a country are imported, then there could be inflation (i.e. a sustained rise in the price of goods and services as importers have paid a higher price which they likely pass to their customers – and they also know that exporters have more money).
Third, those who were keeping dollars in their houses for whatever reason as well as those selling dollars without a licence (black market) will start to sell their dollars to the banks because it is now attractive to sell dollars at K200 each than the previous K150 each.
But why would government ever wish to effect devaluation if it causes import prices to be so high and even cause inflation? While this is a straight forward and valid question, the answers can be slightly complex and depend on economy context.
Put simply, devaluation would normally occur when there are few dollars in the country. So in a bid to encourage more dollars to flow into the economy, government can effect a devaluation to incentivise exporters as well as encourage those hoarding dollars to sell them. This would bring more dollars into the banks which we so much need for various imports.
So when you see the Reserve Bank of Malawi grappling with a devaluation decision, it is because it looks at the pro and cons around the economic growth effects while mindful of the deleterious poverty-enhancing effects that could arise in the process due to inflationary pressures. Fortunately, it has a number of tools to detect and mitigate for the various impacts of such policy decisions. This includes controlling for the levels of Kwachas in the economy because the more the Kwachas people have, the higher the likelihood that they will buy dollars for imports and the fewer the dollars for essentials become.