Why kwacha devaluation wasn’t the solution

May 27 this year marked exactly one year since the Reserve Bank of Malawi (RBM) devalued the kwacha by 25 percent in a move RBM Governor Wilson Banda justified as a necessary evil to align the foreign exchange supply to the macroeconomic fundamentals.

Defined as a deliberate downward adjustment in the value of a country’s currency compared to foreign units, devaluation is a common monetary policy tool that countries use with either fixed or semi-fixed exchange rates.

In the May 30 2023 edition of The Nation, the Business News section carried a story with the headline ‘Forex mismatch widens year after devaluation’. The story stated that one year on, misalignments in the foreign exchange market still prevail with figures showing a 49.61 percent spread between authorised dealer banks (ADBs) rates and the official rate.

While RBM pegs the official kwacha exchange rate to the dollar at K1 036, the local unit is trading at an average of K1 550 in foreign exchange bureaus. This is creating a spread of about K514.

In my July 21 2022 Business Unpacked entry titled ‘Why devaluation may have been a misdiagnosis’ I expressed scepticism that devaluation would improve things, especially amid exchange controls. I did argue that under the circumstances, the parallel foreign exchange market will continue to thrive and be attractive.

Sentiments from financial market analysts and economists in the story ‘Forex mismatch widens year after devaluation’ published on Tuesday this week, confirm that devaluation was a “misdiagnosis”. The kwacha continues to be under extreme pressure because demand for foreign currency continues to outweigh supply.

In other words, the move has not yielded the results RBM hoped for. Sadly, though, a majority of Malawians continue to be on the receiving end of the harsh economic environment so created characterised by ever- rising cost of goods and services that has weakened their buying power.

It is a disaster when one is misdiagnosed and given a wrong prescription to an ailment. For Malawians, the devaluation is like someone was experimenting with their lives.

Financial services strategist Misheck Esau said the devaluation failed to achieve what RBM wanted because the currency was not backed by measures to restore confidence in the operation of market dynamics for price discovery. He rued the fixed exchange rate regime Malawi continues to pursue, saying it has fallen flat on its own sword, pushing the country back to square one.

Devaluation has always been a sticky issue in Malawi and I recall between 2010 and 2012, former president Bingu wa Mutharika, now deceased and may his soul continue resting in eternal peace, stood firm against it. He premised his argument on the fact that the move would hurt local consumers while benefitting importers more as Malawi was a predominantly importing and consuming economy with negligible exports.

But Bingu’s successor Joyce Banda bowed down to the pressure and devalued the kwacha by 49 percent. The rest is history, as they say.

Malawi’s economic landscape has not changed much from Bingu’s time. It remains a net importer. Meaningful manufacturing for high-value exports is negligible or non-existent. Tobacco, the main foreign exchange earner, is not generating enough forex as it has averaged $200 million, a far cry to help the cause.

Theoretically, when a currency is devalued, exports are expected to be competitive on the international market, thereby generating more foreign exchange inflows while imports become expensive. But the Malawi economy is a unique one in that it is usually “nonresponsive”.

In a paper titled ‘Is devaluation an option for Malawi’s current debt challenges’ published before the May 27 2022, economists Thomas Chataghalala Munthali and Frank Ngalande warned that devaluation should not be an option as it would cause more harm than good.

I maintain my position that devaluation amid exchange controls will always make the parallel foreign exchange market flourish. The decision was a misdiagnosis such that it cannot heal our economy’s perennial problems. In other words, the patient appears to be non-responsive to treatment.