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IMF for flexible exchange rate


By Taonga Sabola

The International Monetary Fund (IMF) has said allowing for greater flexibility in the exchange rate, containing external imbalances, and rebuilding reserves are critical in reducing Malawi’s vulnerabilities to external shocks.

The IMF’s observation comes at a time the exchange rate has remained relatively stable at around K825 to the dollar despite depleted foreign exchange reserves.

In its Country Report No. 21/269, the IMF says given the chronic shortages of foreign exchange and low reserves, and to support the start of the adjustment, a rapid adjustment towards a market-clearing exchange rate is necessary.

But the government is of the view that allowing for a rapid greater flexibility in the exchange rate will result in a spike in inflation as was observed in the 2012 episode.

According to IMF, with the anticipation of an adjustment at a future time, hoarding of foreign exchange by market participants may be exacerbating shortages.

In its policy advice to the Malawi Government, the fund says the adjustment towards a market-clearing rate may be accompanied by a temporary spike in prices and that it does not have to be followed by a prolonged period of Kwacha deprecation and inflation as in the case of 2012-16 episode, if RBM were committed to contain reserve money growth.

“It is important to support this adjustment with a credible fiscal adjustment programme. In the 2012 episode, the fiscal policy stance was not compatible with the tight monetary policy stance.

“The deficit from 2012/13 to 2015/16 averaged 7 percent of GDP; and in 2012/13 the deficit widened by 2 percent of GDP (from 5.8 to 7.8 percent). Thus, there was continued pressure on the exchange rate, and hence inflation,” the IMF says.

According to the fund, given the misalignment in the real exchange rate and unsustainable level of current account deficits, over the medium term, a sufficient adjustment of the Real Effective Exchange Rate, in the range of 30 percent, is necessary to improve the competitiveness of Malawi’s exports, contain growth in imports and bring the current account deficit back to more sustainable levels.

“Given that Malawi has large energy-related imports, the authorities also need to carefully calibrate the pace, cost and effects of their energy strategy. Malawi needs to include cost-effective investment in alternative energy sources away from firewood and charcoal— which aggravates deforestation, land degradation, and vulnerability to floods, landslides and food insecurity— and move towards sustainable power generation mix, guided by Malawi Renewable Energy Strategy (2017).

“In transition, these energy-related policy choices may put pressure on the foreign exchange market,” IMF says.

According to the country report, the authorities are of the view that a gradual exchange rate adjustment is the preferred policy option.

Government notes that, in the meantime, the Reserve Bank of Malawi is addressing obstacles to forex market development to deepen the foreign exchange market and pave the way for market-determined exchange rate by eliminating the daily K5 band or the so called ‘reasonable difference’ among bids submitted by banks imposed by Guidelines for Foreign Exchange Trading Activities.

“The authorities agree that rebuilding reserves is a top priority and plan to adopt a reserve management strategy with a view to rebuild reserves going forward. However, switching from being a net seller of forex to a net purchaser of forex in the short to medium term is seen as unattainable given tight liquidity conditions.

“The authorities are working on expanding the export base to include mining and non-traditional agricultural exports like legumes, maize, and industrial cannabis which will increase exports proceeds,” reads the country report.

Last week, the Economics Association of Malawi (Ecama) and the Financial Market Dealers Association (Fimda) questioned the valuation of the local trading unit the Malawi Kwacha against major trading currencies, saying the current fundamentals do not support the stability of the kwacha.

Ecama Executive Director Frank Chikuta said the economists’ body is of the view that the exchange rate should be correctly valued to support exports and contain imports.

On his part, Fimda president Maclewen Sikwese noted that the Kwacha has been overvalued since 2018 but that the level of the overvaluation is steeper now than it been since then and continues to increase.

“Principally the overvaluation has been a function of artificial controls in the level of the Malawi Kwacha which has from 2018 not been allowed to respond to market demand and supply dynamics.

“Whilst theoretically a fair valued exchange rate should help rein in imports and boost exports from affordability and competitiveness perspectives respectively, what is critical is to look at the sensitivity of our exports and imports to exchange rate changes,” Sikwese said.

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