Key takeaways from devaluation and inflation behaviour

What are the key takeaways so far from the government’s decision to intentionally reduce the value of the Malawi kwacha over the past 12 months?

There have been two double digit devaluations in the last year and multiple single number depreciations during Reserve Bank of Malawi’s (RBM) foreign currency auctions—cumulatively estimated at around 100 percent.

Yet inflation rate figures, while still high at 33.42 percent last month and likely to surge further over the remainder of 2024, are not as scary as one would have expected after such sharp RBM-forced softening in the local unit.

In fact, in some months over this troubled period, the general rise in prices actually moderated when everyone else had been complaining that prices of goods and services in the country were rising at a pace few would keep up with on the back of the official kwacha moves.

Indeed, demands for salary and allowance increases have been based on those devaluation levels having triggered nominal increases in goods and services although actual inflation has been much lower than the devaluation levels.

The push for upward compensation reviews have since resulted in disagreements between various unions and the Malawi Government.

The collapse in labour talks has now ended up in industrial actions by workers in certain sections of the public sector such as the Judiciary whose support staff downed tools from Thursday and Health, whose sit-in is expected to start around June 10.

I was just looking at national inflation figures from December 2023 to April 2024 that came after the 44 percent devaluation of the kwacha effected in November last year.

The figures show an increase in inflation of just 6.3 percent from 34.5 percent in December last year to 32.3 percent in April (last month) while the average inflation rate for the five-month period stood at 33.42 percent.

In fact, before ticking up in April, there was a two-month decrease in the annual inflation rate in February and March.

During the December-April period, non-food inflation barely moved, scintillating within the 22 percent band and actually fell marginally.

Food inflation too remained moderate, which may also explain the flattening of the headline inflation curve given that food accounts for around 58 percent of the country’s consumer price index.

Given the inflation data after the devaluations, a few things are becoming clear. The first is that authorities, no matter how much they try, have very little control over the real value of the kwacha as long as it is being traded.

While monetary authorities can try to suppress the official rate, the markets will continue to trade based on demand and supply forces and the exchange rate will be determined on that basis by players in the industry who ignore the government’s stances in order to keep their businesses going.

And so the central bank has really become a follower, chasing after the real market rate and by the time they devalue, businesses will already have priced in the real value of the currency into their price structures.

Thus, when you take imported inflation, for example which after food, particularly, maize, remains the second most driver of inflation in Malawi, traders add a mark-up after devaluation simply because they are business people who must take advantage of a regulatory or policy decision to make money.

That explains why after devaluations, non-food inflation stayed largely in straight lines and food inflation numbers rose fairly modestly.

The second issue that is clear is that timing is everything. Devaluations that come when prices for key commodity prices (maize in the case of Malawi) are already way up, the chances are that they are unlikely to rise any further.

That is almost exactly what happened over the past five months, although the start of the harvest period played a part to dampen maize prices.

Indeed, the November devaluation did not have much impact on food inflation. Moreover, during that period, government made a lot of maize available in Agriculture Development and Marketing Corporation markets at prices that were much lower than those offered by private traders, which kept prices of the grain steady.

In addition, aggressive distribution of free maize and flour nationwide had the additional dampening effect.

The third issue that has become clear is that while a tight monetary policy has hurt many businesses and households through high financing costs, it has gone a long way to holding the national inflation rate low having left very little liquidity to loiter around and wreck unproductive macroeconomic havoc.

C l e a r l y , t h e r e f o r e , contractionary monetary policy has helped to contain inflationary pressures following the twin devaluations and depreciations from the forex auctions. For example, RBM has progressively increased the policy rate from 12 percent in April 2022 to 26 percent currently.

During the period, the central bank has also increased the liquidity reserve requirement ratio on domestic currency deposits from 3.75 percent in April 2022 to 8.75 percent at the moment.

But how sustainable is the current monetary policy stance? Because if the April inflation data is anything to go by, the general rise in prices will persist in 2024 on the back of food prices that are likely to creep back up what with El Niño-induced weather conditions characterized by below-normal rainfall and extended dry periods.

Of course, government is giving the impression that mega farms should produce enough maize through irrigation to keep the grain’s prices low, but will it?

M o r e o v e r, w h i l e t h e International Monetary Fund’s recently approved $175 million Extended Credit Facility arrangement has triggered a release of direct budgetary support that has helped to shore up the country’s balance of payment capabilities, the stubborn imbalances that haunt the Malawi kwacha remain.

The shocks—both internal and external—have refused to take the hint and go away. Economic growth is failing— literally. And the cycle remains too vicious even for the much talked about ATM (agriculture, tourism and mining) strategy to break.