According to the Reserve Bank of Malawi, exchange rate administration in the country aims at attaining three main objectives which include: Attainment of growth in real income; Maintenance of a viable balance of payments position; and Attainment of stable domestic prices. The Banks indicates that "these objectives were attained to some extent in the 1970s; but, owing to both external and internal factors, they were difficult to achieve in the 1980s." [1] Therefore, presented below is a brief history of the exchange rate policy in the country implemented in the quest to achieve these objectives.
Pegging of British Pound to Malawi pound system (1965-1973).
From 1965 the Malawi currency was fixed at one to one ratio with the British pound sterling until 1973. However, the currency was freely floating against the US dollar and other trading partners.
Pegging of Malawi Currency to weighted Basket of British Pound and the US dollar (1973-1975).
In 1971 the Malawi currency was renamed from pound to Kwacha and from 1973 the country linked the currency to a weighted basket of the British pound and the US dollar.
During this period the central bank pursued dynamic exchange rate policy, which involved explicit devaluations when a need arose.
The Peg to the IMF SDR (1975-1984).
From 1975, the Kwacha was pegged to the IMF's Special Drawing Rights (SDR). This arrangement was short-lived as the SDR began to appreciate in response to the US dollar hence the Kwacha also appreciated. This affected export development.
Peg to the Weighted-Basket of Seven Currencies (1984-1994)
Despite the devaluations carried out in 1982 and 1983, the country's external situation continued to deteriorate, thus in 1984 authorities de-linked the Malawi kwacha from the SDR and pegged it to a trade weighted-basket of seven currencies representing the geographical composition of Malawi's trade and the currencies used in settling the country's international transactions.
Floatation of the Malawi kwacha (February, 1994-2012)
In 1988, the Malawi government embarked on structural adjustment program, as such, in 1994 the foreign exchange market was completely liberalized and the kwacha was allowed to float freely. However, from 2007 to 2012, the country relied on a managed float (almost fixing the kwacha to the dollar) after it noticed that there were great fluctuations in the value of the currency against major trading partners. From 2012 the country reverted to the free floating system. [2]
2.2 The Real Effective Exchange Rate (REER) Trend
The REER is a weighted exchange rate of several currencies of major trading partners against the local currency. Graph 2.1 below indicates that the Malawi Kwacha has been losing its value in real effective terms over the period 1980 and 2010. However, there is need to test if this loss in values is statistically significant. The major goal has been to make exports competitive so as to improve the trade balance situation in the country.
Source: World Bank database [3]
2.2 Trade Balance, Exports and Imports Trend
Trade deficit as a percentage of GDP has been deteriorating since 1980 as can be observed in the upper section of graph 2.2 below. This can be attributed to the fact that imports have been increasing more than exports over the period under review as presented in lower section of graph 2.2. Of significance is the fact that imports and exports have also been moving in the same direction over the period under review. In periods where exports increased, imports also increased and where exports decreased, imports also decreased. This suggests that devaluation increases imports and exports and appreciation decreases both exports and imports in the short term.
Source: World Bank database
2.4 Composition of Exports and Imports and Reasons for Fluctuations in Trade Balance
Agriculture is the main stay of the economy as it contributes an average of 32 percent to Gross Domestic Product (GDP) over the period under review. It also accounts for approximately 90 percent of total exports. The major crop in the export basket is tobacco, constituting 53 percent. Other major exports include tea, sugar, cotton and coffee. "The agricultural sector employs 87 percent of the country's labor force and rural areas are home to 85 percent of the population" doing subsistence farming. Such being the case and from the fact that Malawi is a small economy, which means its export market is not limited, improvements in exports and trade balance, have mainly been attributed to good performance in agriculture sector from good weather and other interventions that boot production other than the depreciation of the Malawi currency. [4]
Fertilizers top the list of the fastest growing imports due to the fact that the economy relies significantly on agriculture. Second on the list are petroleum products, which include petrol diesel and paraffin. The other major imports are manufactured food stuffs and beverages, and machinery and equipment. As the economy grows, the demand for these imports has also increased sharply since they are necessary raw materials for production in the economy. These items are not produced in the country; as such, increasing prices due to devaluation has not deterred importation of these goods significantly as they are essentials. As such, devaluation has not heavily improved trade balance over the period under review since imports also increased when exports increased due to devaluation. [5]
