Putting inflation drop into perspective

It is obvious that at the time of writing this piece, both Reserve Bank of Malawi (RBM) and the Treasury, who are custodians of monetary and fiscal policies, respectively, are over the moon with this talk in town about Malawi’s regained single digit inflation.

Over the past six years, authorities have been battling double-digit inflation—the rate at which the general level of prices for goods and services rises— and only to win this war in August 2017 when headline inflation plummeted to 9.3 percent. This was, and is still good news worth smiling about.

Basic facts on the ground are clearly in tandem with such a trend largely because the country is in the midst of bumper yield. At the same time, there is still a ban on exports, thereby artificially suppressing maize prices, which traditionally dictate inflationary trends.

It was between 2007 and 2011, when Malawi enjoyed this single digit inflation due to a stable exchange rate during the fixed exchange rate regime and also owing to recurring good maize harvests then.

But since December 2011 (9.8 percent rate), it was apparent that both fiscal and monetary policy experts had lost plot and were grappling to maintain price stability. This did more harm than good as it saw purchasing power for many Malawians dwindling drastically over the past years.

Now going back to this news that we are back to the single digit lane, there is need to celebrate this with caution.

Going by a flurry of writings on social media, it is evident that there are some segments of society misinterpreting this single-digit inflation buzz.

Some are still smiling ear-to-ear thinking that prices of bread, cooking oil, sugar, maize and other basic goods and services will begin to go down, courtesy of single-digit inflation. This is economically absurd.

If this single-digit inflation is sustained in the short to medium-term, it simply means that the speed at which commodity prices would rise will be reduced. In economics, it is understood that with declining inflation, prices of basic goods and services would still increase, but at a decreasing rate.

In macro-economic lens, falling inflation rates generally pose as a conducive environment for monetary authorities to implement expansionary monetary policy which,  among others, involves cutting interest rates or increasing money supply to boost economic activity.

Tellingly, this short-term period of disinflation has created room for other economic factors such as interest rates and the exchange rate to improve.

This year, RBM has slashed the policy or base lending rate twice from 25 percent to 22 percent and then to 18 somewhere in July. In response, banks have followed suit by cutting their respective lending rates, albeit with unsatisfactory small margins.

It is evident that in Malawi and elsewhere, prudent fiscal policy, when combined with far-sighted monetary policy, pays-off dividends.

High and persistent inflation over the past years was a creation of a disconnect between fiscal and monetary policy, combined with other exogenous (external) factors such as weak agricultural output, volatile international oil prices, among others. But a concoction of all these created a special kind of inflation called supply push inflation (as opposed to demand pull inflation) which has been tormenting Malawians hard, by eating into income levels of many.

Recent high inflation coupled with high interest rates that peaked to around 45 percent in some banks, created a weak private sector investment atmosphere, a slowdown in household consumption, and consequently, pulled down high economic growth rates trajectory.

Don’t put into oblivion also that recent huge appetitive by treasury for domestic borrowing also played a role in delaying this much-anticipated single-digit inflation, while exerting pressure on interest rates, let alone crowding-out the private sector.

In my view, this single-digit inflation is one of the indicators that the Malawi economy needs to sustain over a long period of time for the economy to turn the corner or achieve stability. It should not be the ultimate policy goal but rather the desired path.

In other words, the attained single-digit inflation should be deemed by politicians as a necessary condition but not sufficient enough to stabilise the economy.

Economic stability entails a stable macroeconomy which has constant output growth as measured by Gross Domestic Product (GDP), low and stable inflation as well as low public debt, among other macro-economic variables.

It is also high time monetary authorities moved  the  policy away from inflation targeting to interest rate targeting to spur production. By lowering interest rate, inflation tend to skyrocket in the short run because people access cheap capital. However, in the medium to long run, high output floods the market and this brings down inflation, ceteris paribus (holding all other things constant).

As it stand now, monetary and fiscal authorities cannot afford the luxury of being complacent with declining inflation rate. The onus is on fiscal and monetary policy experts not to exercise laxity but rather tighten all loose nuts.

Unless recent macroeconomic gains such as stable exchange rate, declining interest rates, and some level of fiscal discipline, are consolidated, the country may run the risk of falling back into the abyss of double-digit inflation pit.