Peter repeats brother’s gamble, but is context the same?

There was good news recently from the Reserve Bank of Malawi (RBM) as the monetary policy rate dropped by 2.5 percentage points to 22.5 percent effective July 9 2014.

In making the decision, RBM’s monetary policy committee (MPC) said falling inflation on the back of widely available maize—the staple grain that has the heaviest weight in the consumer price index (CPI)—was a leading determinant in the policy rate cut.

The relative stability of the exchange rate and subdued prices of fuel also provided the much needed nudge to the committee.

There is no doubt that the interest rate cut is a helpful move for the private sector, consumers of credit, government itself and the economy in general.

The high cost of borrowing—lending rates currently range from 35 percent to 40 percent—are strangling businesses as they increase operational and investment costs.

High interest rates have either discouraged people from borrowing or gnawed at the disposable incomes of those who have braved the harsh terms, thereby depriving the economy of the much-needed consumer spending that keeps businesses in business. Government , too, has had to dig deeper in the pocket to borrow from the domestic financial market. This increased Capital Hill’s debt repayment budget and worsened the domestic debt overhang.

In the end, the economy in general suffered from the high price of money. So, it is great to see that commercial banks have started responding to the RBM’s interest rates direction by making reciprocal cuts to lending rates and increasing—albeit modestly against inflation—the deposit rates. Indeed, the economy could get a boost.

But I suspect the policy rate cut is more about experimenting with an offensive or activist monetary policy rather than being informed by fundamentals on the ground, which remain too fragile to accommodate such a bold move—as well-meaning as it maybe.

It is a typical Democratic Progressive Party (DPP) policy psyche. They did this under the late leader Bingu wa Mutharika—cutting interest rates even when the inflation rate was in its advanced 30s.

They did not wait for the inflation rate to drop significantly—knowing that it could be a long wait, too long maybe for a suffocating private sector.

Whether it was luck or simply good policy manoeuvring, the calculated gamble worked, of course also because it was accompanied by agriculture input-powered record bumper maize yields that helped drive down inflation and, with it, further pulled interest rates down.

For four consecutive years, Malawi’s economy grew sharply—averaging seven percent annually—helped largely by agricultural performance, but also private sector expansion even though it was to a smaller extent.

So, here we are again—President Peter Mutharika’s administration, like his brother’s before him, has also taken a similar gamble.

But there is a huge difference that raises the risks for the Peter government: budgetary support. Granted, when Bingu took over from Bakili Muluzi, Malawi’s economic programme with the International Monetary Fund (IMF) was, just like today, also off track.

The difference is that donors at that time used to listen to the IMF and were more uninformed than today.

Therefore, when the Bingu government negotiated for a one-year IMF staff monitored programme (SMP) during which it would demonstrate its commitment to improving public financial management and reform the economy, the fund signalled to donors that they could start releasing aid and most of them cautiously did.

Within a year, not only had Malawi returned to the programme, it also qualified for debt relief and donor resources poured in to support the new economic agenda.

Today, not only do bilateral donors not listen much to the IMF, they have made it clear that there will be no budget support in 2014/15 on the back of Cashgate and, they have said, they cannot guarantee aid return even next fiscal year.

Secondly, the disbanding of the Common Approach to Budget Support (Cabs) has just widened further the gulf among donors, which means it will even be harder for Capital Hill to convince donors as a bloc to unfreeze budgetary support.

Thus, while RBM cites the stable kwacha as a factor in its interest cut decision on the basis that it will help arrest inflation, the donor aid drought and the uncertainty that has come with it are risks to the local currency’s constancy and, therefore, the inflation outlook.

Sure, the kwacha is likely to remain stable and even appreciate in the short-term, thanks to the current reserve war chest, largely from tobacco proceeds.

According to Nico Asset Managers, foreign exchange reserves as at June 27 2014 increased to $820 million, an equivalent of 4.29 months worth of import cover compared to $780 million or 4.09 months worth of import cover as at May 31 2014.

Of the total reserves, $478 million was the official reserves or under RBM’s direct control, representing an import cover of 2.50 months while $342 million or 1.79 months worth of import cover was with the private sector.

But what will happen when the tobacco auction floors in October/November close and there is no balance of payment backup from donors?

Where will RBM continue to get forex to sell back into the market during shortages to control the kwacha’s movements?

That is when the inflation troubles could implode as the local currency starts losing its ground in the third quarter, which will also happen to be the beginning of the forex lean period and the time hunger starts to bite nationwide as granaries shrink.

And if the automatic pricing mechanism finally becomes automatic at a time fuel prices head north and as the local currency melts under forex shortage pressures, will the loosened monetary policy turn out to be a good idea or will the administration look back and say we acted too quickly?

The answer will depend on how the markets react to the various shocks going its way and the treatments they will be subjected to.

Good luck Governor Charles Chuka.