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Time for middle class tax break

Charles Chuka, barely a month in office, has become the first Reserve Bank of Malawi (RBM) Governor in about a decade to raise the bank rate—the rate at which commercial banks borrow from the central bank and which traditionally is the benchmark for lending and deposit rates adjustments.

 

On Friday, the RBM announced the upward bank rate revision from 13 percent to 16 percent, representing a three percentage point or 23 percent jump in a move that asserts a tighter monetary policy stance in the wake of the 49 percent kwacha softening, an averaged 62 percent energy price hike (fuel and electricity) and a sharp rise in liquidity levels that have brought fresh inflation worries.

The decision, coming five days after devaluing the local unit from K268 to K250, is a brave move that signals pragmatism and independent decision-making that could herald a new era for the central bank in which the Monetary Policy Committee (MPC) could become relevant again.

But most importantly, the two monetary policy decisions may also go a long way in helping the RBM to regain its credibility and provide policy clarity to investors, the Malawi public as well as donors.

Chuka, a monetarist throughout most of his career, with influence from his deputy governor (economic services) Dr. Naomi Ngwira, a respected hawkish economic policy guru and unabashedly market-oriented technocrat, seem set to restore the RBM’s integrity.

The new top team at the RBM has signalled their intention to wrestle back the monetary authority role from State House that the late president Bingu wa Mutharika snatched from it.

In other words, monetary policy will, where appropriate, be allowed to check the excesses of fiscal policy, without unnecessary political encumbrances and complement each where necessary.

The last governor to raise interest rates was Dr. Elias Ngalande, an academic, who upped the bank rate from 40 percent to 45 percent in June 2003.

After that, however, Ngalande progressively cut the bank rate to 25 percent by the time the then new President Mutharika, now deceased, fired him in February 2005.

Prior to June 2003, Ngalande raised the bank rate to as high as 75.5 percent in March 2001, before bringing it down as he tried to tame a snarling inflation rate.

His successor, commercial banker Victor Mbewe, further cut rates to around 13 percent by the time Mutharika relieved him of his duties in July 2009.

Career economist Dr. Perks Ligoya, who replaced Mbewe in September 2009 and who President Joyce Banda sacked a few weeks ago, never tinkered with interest rates even when all economic fundamentals begged an upward revision.

Instead, Ligoya spent most of his RBM time grappling with the exchange rate policy, hunting for dollars and fielding duelling calls from the International Monetary Fund (IMF) and Mutharika who constantly clashed with the Brettonwoods institutions over the devaluation of the local currency.

The late leader was against devaluation, saying it would trigger high commodity prices and hurt the poor. But, as many analysts have pointed out, Mutharika was only delaying the pain, not preventing it.

In fact, owing to the delay, the cancer has spread so much that to save the ailing Malawi economy, a number of painful medical procedures-devaluation, higher interest rates as well as energy prices and whatever else-have to be done almost simultaneously with excruciating pain as the result.

Already, the devaluation of the kwacha has brought a lot of pain at the fuel pump, a development that-with its cost-push effects-will bring more pain in supermarkets where goods have gone up and in the buses or minibuses as fares climb.

Second round post-devaluation prices of goods may also be on the way as distribution costs swing after a push from fuel price increases.

The bank rate hike feeds into the now familiar narrative of the almost unbearable pain Malawians are enduring.

First, as the cost of borrowing jumps on both old and new debts, government is likely to allocate more resources in the national budget to domestic debt interest repayments at the expense of other critical areas within the recurrent budget such as drugs.

Given that debt repayment is a statutory obligation, it is unlikely that the Banda administration will skip it, especially after the previous one defaulted in the current fiscal year, a move that was not only embarrassing but also costly to the fiscus and further eroded the country’s credit worthiness.

At individual level, employees with bank loans are set to see higher deductions on their pay slips beginning end this month.

Companies, too, will have to cough more for old and new loans, thereby spilling red ink all over their operating margins.

To remain afloat, businesses may also share the interest-induced pain with already weary consumers whose real incomes are dwindling.

If the government does not use the right policy mix to relieve this pain, the new administration could face social anarchy, especially from the middle class who are being ignored as most of the cushioning measures are largely targeted at the poorest.

Most of the safety net proposals that the World Bank has promised to offer to help cushion the effects of devaluation such as cash transfers are aimed at the lowest end of the poverty ladder while the working class are left to fend for themselves.

Only the national budget can help the middle class through a tax overhaul that leaves more money at their disposal.

Thus, the next budget may do well to cut income taxes, especially pay as you earn (Paye) for the middle income earners from the current 30 percent to around 25 percent.

The budget should also revise consumer taxes, especially Value Added Tax (VAT) from 16.5 percent to around 12 percent and put in place measures that will ensure that companies make reciprocal reductions to prices and services.

Granted, these revenue measures could dig a hole in the budget. But if government can close loopholes such as those that allowed civil servants to steal K4 billion (some say it could be more) through the now discredited government accounting system called IFMIS and other forms of waste, the savings could help fill the gap.

Secondly, the World Bank and the IMF committed to help cushion against the effects of devaluation. Well, apart from the pro-poor strategy, they should put some money into the budget to pay for the foregone taxes as a result of the middle class tax cuts.

The tax breaks do not need to be permanent. They can be done over a two-year period and, if well managed, could even be an effective stimulus to the economy.

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