Questions on 2013 monetary policy

In the year 2013, marked with the cashgate, donor aid freeze, rising food prices and a tumbling kwacha, the Reserve Bank of Malawi (RBM) maintained its tight monetary policy.

Regardless of a fall in inflation—the general rise in the prices of goods and services— between March to September 2013 and tight liquidity, the central bank maintained a 25 percent bank rate—the rate at which commercial banks borrow from the central bank as the lender of last resort.

The RBM argued that the tight monetary policy was important to rein in inflation, counter the fall of kwacha while at the same time cleaning the fiscal mess that characterised the year.

Analysts applauded the tight monetary policy while urging for discipline in the implementation of the fiscal policy. Others noted the tight market liquidity and rising interbank lending rates risked to increase lending interest rates.

The year 2013 started with rising interest rates at over 36 percent as a result of an increase in RBM’s base lending rate which was increased to 25 percent from 21 percent in December 2012.

Around mid-March 2013, interest rates rose again to over 40 percent largely due to a tight market liquidity which was due to heavy government domestic borrowing forcing Treasury Bill (T-Bills) rates to rise to 43 percent.

But as the liquidity improved mid-2013, commercial interest rates dropped by an average two percentage points to 38 percent and have been maintained at that rate to date.

Along with high interest rates, depreciation of the kwacha, rising food and fuel prices up the 2013 average inflation to 28.6 percent from 26.9 percent projected earlier, according to analysts.

During the year, inflation rose to 35.1 percent in January before peaking at 37.9 percent in February, according to the National Statistical Office. It turned the corner to drop to 36.4 in March and continued on a month-to-month decline up to October when it rose to 22.2 percent from 21.7 percent in September. The November inflation peaked at 22.9 percent.

The kwacha did not behave any better than inflation and interest rates. After a 49 percent devaluation and floatation of the local unit in May 2012, the kwacha behaved like a pendulum, oscillating to a peak of around K330 to a dollar in June on the back of a good tobacco marketing season.

The kwacha, thereafter, peaked to around K450 to the dollar in December regardless of better foreign exchange availability as reflected in relatively higher official and private sector reserves.

The RBM, however, argued that the sharp kwacha depreciation reflected largely the loss of donor support which constrained the central bank’s ability to defend the local unit.

So, regardless of the tight monetary policy, the kwacha could still not be defended while inflation rose to an average worse than the previous year.

But how was the average person been affected by at least high interest and inflation rates and a falling kwacha?

As interest rates rose, consumers and businesses could not borrow to meet their needs, and consequently struggled to service their loans as indicated by rising default rates.

The fall of the kwacha made the cost of living unbearable as imports, including fuel prices rose.

To save the situation, the latest Monetary Policy Committee (MPC) meeting held on December 10 2013 noted that to contain the kwacha depreciation, there is need to further tighten the monetary policy and fully implement the fiscal measures announced recently and as agreed with the International Monetary Fund (IMF).

In November 2013, Financial Market Dealers Association (Fimda) president Alfred Nhlema, commenting on monetary policy implementation, observed that the RBM will intensify the application of open market operations to mop up any excess liquidity in the market to dampen exchange rate pressure and the resultant imported inflationary pressure.

Nhlema said given the current market challenges, the economy still needs a tight monetary policy stance to tame inflationary and exchange rate pressures, while calling for continued fiscal expenditure restraint so that monetary policy is not in vain.

While the RBM fears for an increase in money supply ahead of the May 2014 Tripartite Elections, the Malawi Confederation of Chambers of Commerce and Industry (MCCCI) forecasts that the business environment will get worse in early this year in light of the elections.

“Inflation is likely to be out of control when cashgate money starts vote buying and donations and gifts, even in excess of annual incomes of those making them, steal the show. Malawians should therefore brace for tough times.

“Businesses are, therefore, likely to be at standstill. When customers cannot buy products, businesses find it difficult to thrive,” reads the MCCCI press statement released this week.

But looking at the rising inflation, falling kwacha and high interest rates in the face of a tight monetary policy, questions still linger on the effectiveness of RBM’s interventions.

Perhaps the answer lies in a 2011 research by Chancellor College economist Ronald Mangani on the effects of monetary policy on prices in Malawi.

In the paper, he recognised that the economy is characterised by market imperfections, fiscal dominance and vulnerability to external shocks and observes that imported cost-push inflation is more pressing than inflation arising from money market conditions.