Devaluation in Malawi free essay sample

Introduction Devaluation occurs when the price of one currency is officially decreased against other currencies. Devaluation takes place in a fixed exchange system based on government policy decisions (Tembo 2012). Recently, the government of Malawi through the Reserve Bank of Malawi (RBM) has devalued the Malawi Kwacha by 49% and untied the currency from the dollar. The Reserve Bank of Malawi devalued the Malawi Kwacha exchange rate from K168 to K250 per United States dollar. This was done to meet the demand of the International Monetary Fund which has been refused for some time. . 0 Devaluation trend in Malawi In 1967, Malawi experienced the first devaluation of 14% which was implemented on the British pound since the currencies for the two economies were at par. Between 1973 and 1975, the RBM started pursuing an active exchange rate policy which involved devaluation of the Malawi Kwacha when a need arose (Tembo 2012). Since the establishment of an active exchange rate, the Malawi kwacha lost value again in 1982 by 15%. Devaluation has also been happening in the past years up to date. Devaluation trend in Malawi starting from 1988 is depicted in table 1 in the appendix. 3. 0 What triggered devaluation 3. 1Few forex reserves inflows to finance imports The countrys long standing foreign exchange problems intensified in 2011 because of lower tobacco export earnings and cuts in external aid as several donors reduced their financial support to Malawi when the authorities IMF-supported program went off track in the first half of 2011 and because of human rights and governance concerns (IMF 2012). This pushed Malawi towards financial collapse. . 2Trade deficit In Malawi, the value of imports is more than value of exports. This means that the amount of goods imported from outside exceeds the amount of goods we export hence making Malawi a net importer. This can be due to the fact that our locally produced goods seem to be expensive on the international market thereby making foreign countries less willing to import more. In order to improve foreign exchange shortages, trad e deficits and to woo back international donors, the government decided to devalue its currency. According to Reserve Bank of Malawi statement (2012), governor Charles Chuka said that the move was intended not only to improve the availability of foreign exchange and unlock donor flows, but also to reduce demand for imported consumer goods in favour of domestically produced goods. 4. 0 Reactions of the general public The response by Malawians, however, has been mixed. Some people seeme to be positive about devaluation while others are crying foul. 4. 1 Reason for negative reactions . 1. 1 Leads to inflation Devaluation leads to inflation especially on goods that use imported raw materials and as well as due to transportation cost (rising cost of fuel) (Tembo 2012). Most Malawians complained about devaluation; although the prices of goods and services have risen up, wages or income for most of them remains constant. Furthermore, importers, have tended to suffer and, with inflation rocketing, the prices of imported goods and services have also significantly risen. The Chief Executive of the Consumer Association of Malawi, John Kapito, pointed out that Malawi is a landlocked country and heavily dependent on imports, so any weakness in the kwacha was bound to have negative consequences for consumers (IRIN 2012). The graph in the appendix depicts the inflation trend between April,2011 and April 2012. Since the purchasing power is usually reduced due to inflation, most Malawians have shown their anger after devaluation through strikes since their incomes have remained the same. The devaluation of the kwacha by 49 percent in May and the general hard economic environment have sparked a spate of strikes in companies and institutions which aimed at an increment in peoples income. An analysis by the Daily Times shows that most of the strikes began after July 1, when the current national budget was adopted, which means between May and June people were looking forward to July to see if government and other companies would put in place economic measures that would cushion them from the negative effects of the devaluation (BNL Times 2012). Table 2 in the appendix depicts some of the strikes that has occurred since devaluation. 4. 2 Reasons for positive reactions 4. 2. 1Increase export earnings Most Malawians who export goods and services, especially tobacco farmers, supported devaluation since a weakened currency has been particularly good for exporters such as tobacco farmers who sell predominantly to foreign firms for US dollars. Julian Chidumu from the Tobacco Control Commission, for example, said: â€Å"we are very happy with the devaluation because the tobacco prices are good on the market and we have seen already the prices are actually picking up which is very good for the famers† (Think Africa Press 2012). 4. 2. 2 Winning back international support Some people also supported devaluation since it was done to win back international support in a country heavily reliant on aid. Following devaluation, donors have responded with renewed pledges of support. For example, the IMF announced its intention to start a new programme to replace the three-year Extended Credit Facility, which was frozen last year and expired in February 2012. The World Bank promised to collaborate with the IMF mission on a rapid response operation to provide technical support to the 2012/13 budget and vowed to finance community-focused projects such as the Malawi Social Action Fund, the Local Development Fund and the Irrigation, Rural Livelihood and Development fund (Think Africa Press 2012). 4. 2. 3 Attract investors and increases foreign reserves Other people supported devaluation since it will attract foreign investors; at the same time increasing foreign reserves, expanding domestic production to meet local and export demand and also creating jobs hence economic growth. According to Nyasa Times (2012), most economists agree that the new exchange rates should help attract foreign investment, thus increasing the country’s foreign exchange reserves and making it easier to import those things that had become so scarce in the past months: medicine, for example, and petrol. In addition, devaluation will also make Malawi’s exports much more attractive on international markets hence generating more foreign reserves. 5. 0 The role played by trade unions Most of the trade unions blamed the government for devaluing the currency considering the hardships that most workers will pass through hence demanding wage increments in both government and private institutions. According to Luther Mambala, president of Malawi’s Congress of Trade Union, an umbrella body of Malawi’s trade unions, argues that the devaluation will have a particularly significant impact on the low-income earners. We are now planning to engage into negotiations with the government which is the biggest employer in Malawi to consider increasing salaries of the workers to match with the recent prices for goods and services,† he explained (Think Africa Press 2012). Furthermore, Robert Mkwezalamba, Secretary General Malawi Congress of Trade Union (MCTU)—a body that champions the rights of workers, told Blantyre News Limited on August 2, 2012, that that the strikes are justifiable given that cost of living has shot up yet most companies are reluctant to duly raise pay. He further said that Malawian Congress of Trade Unions is fighting for a 40% wage increase for the formal sector, but 88% of Malawians work in the informal sector where wages are not fixed and the devaluation has squeezed their already meager profits pushing them further into poverty hence the union will also fight back to protect informal workers. 6. 0 conclusion In conclusion, devaluation was really relevant but it is not the only key to economic recovery. It is one of the keys that is useful in assisting Malawi to access Extended Credit Facility, unlocking donor fund, and increase export earnings (Tembo 2012).