Malawi recently devalued its currency, the Kwacha, by approximately 44 percent against the US dollar, adjusting the exchange rate to 1,700 kwachas to the dollar from its previous rate of about 1,180 kwachas to the dollar. This decision marks the second substantial devaluation announced by the Reserve Bank of Malawi, following a similar measure in May 2022.
The decision to devalue the Kwacha was prompted by persistent imbalances in the currency market's supply and demand dynamics, alongside the resurgence of arbitrage opportunities and socio-political factors. In this short piece, I shall explain the factors behind the currency's devaluation, its impact, and compare the devaluation of the Kwacha with the fluctuation of the Nigerian Naira, highlighting the pervasive issue of currency instability in Africa. Additionally, I shall delve into the influence of the IMF and other financial actors on Malawi's economy and provide recommendations for addressing macro and microeconomic challenges, steering Malawi towards economic prosperity.
Factors Responsible for Devaluation of Malawi's Currency
Several economic challenges compelled the government to devalue its currency by 44 percent. The decision mirrors the challenges faced by Malawi's economy, particularly concerning foreign exchange reserves and trade dynamics. Persistent supply-demand imbalances and the resurgence of arbitrage opportunities highlighted the necessity for devaluation. Factors such as dwindling foreign currency reserves, rising commodity prices, and declining revenue from tobacco exports contributed to this significant devaluation.
Secondly, the series of shocks, including the Covid-19 pandemic, a surge in global food prices, and a devastating cyclone in March resulting in significant casualties, further exacerbated economic conditions. Furthermore, the official foreign-exchange reserves in Malawi have diminished to 261 billion kwacha (equivalent to 223 million dollars) by the end of September, representing less than a month's worth of imports, according to central bank data. The scarcity of dollars in Malawi has driven people to seek foreign currency, with the dollar available at 1950 per dollar, according to money traders in Blantyre, the commercial capital. Similar dollar shortages are observed in other African nations, such as Nigeria, where a significant gap exists between official and parallel naira rates. Considering these factors, the government opted to devalue its currency.
The Impact of Devaluation on Malawi:
The substantial devaluation of Malawi’s currency will not only have economic implications but also a humanitarian aspect. Some implications and impacts of the devaluation are as follows:
The devaluation will impact trade activities, consumer prices, business operations, household budgets, leading to a further increase in the inflation rate.
Beyond the financial sector, the devaluation will influence various aspects of the economy and the lives of Malawian citizens, affecting the cost of imported goods, inflation rates, and overall purchasing power across different socio-economic strata.
The devaluation may have multifaceted effects on Malawi’s economy, potentially making exports more competitive in international markets while increasing import costs for businesses reliant on imported goods and raw materials.
Diaspora communities may resort to informal remittance channels, contributing to the growth of the informal economy.
The increased cost of food might exacerbate existing food security concerns.
A potential increase in unemployment could lead to a rise in crime rates.
Influence of IMF and International Financial Factors
Malawi's significant trade deficit, where imports surpass exports, resulted in a shortage of foreign exchange. Due to which, Malawi has been dependent on international financial actors including the IMF and other donors to bridge the gap in its foreign exchange reserves. In 2022, the country became the first low-income nation to receive financing from the IMF under a new tool intended to help countries cope with the global food-price shock. Due to these factors, IMF enjoys a substantial influence over the economic decision-making process of the country.
Economists believe that the devaluation was conducted to secure an Extended Credit Facility from the International Monetary Fund (IMF) as the organisation supports devaluation of currency an important factor in stabilising the economy in the long run. This assumption proved correct, as the IMF approved a $178 million loan for Malawi to boost its foreign-exchange reserves, support the debt-ridden nation's economic revival, and catalyze grant financing, occurring a week after the nation devalued its currency. This 48-month extended credit facility will support Malawi in its macroeconomic adjustment and reforms to restore macro-economic stability.
Currency Devaluation in Overall Africa
In 2022, the currencies of most Sub-Saharan African countries weakened against the US dollar. Non-pegged countries witnessed a 7 percent average year-over-year depreciation in official exchange rates, exceeding 20 percent in some cases. Some countries, like Burundi, Ethiopia, and Nigeria, experienced large exchange rate spreads in parallel markets, reaching up to 90 percent at times.
Pegged countries, predominantly fixing their exchange rates to the euro or South African rand, also saw their currencies weaken against the US dollar. Exchange rate pressures led to reserve asset depletion as foreign exchange inflows slowed, compelling central banks to use reserves for imports and foreign debt repayment. An index combining depreciation against the US dollar and reserve depletion showed a six-year peak in 2022 on average, higher in pegged regimes and nonresource-intensive countries. While this note primarily focuses on 2022, pressures against the US dollar have persisted in the 2023 across many countries.
Recommendations to Improve the Economic Conditions of Malawi
Malawi can implement several steps to enhance its economic condition:
Diversify the Economy: Reduce reliance on key exports by diversifying industries into sectors like agriculture (beyond tobacco), manufacturing, and technology, creating resilience against market fluctuations.
Boost Agricultural Productivity: Enhance farming techniques, infrastructure, and research to improve food security and generate surplus for export.
Attract Foreign Investment: Create an environment conducive to foreign direct investment through incentives, improved infrastructure, and streamlined bureaucratic processes.
Enhance Trade Balance: Increase exports, foster trade agreements, and invest in value addition to raw materials before export.
Strengthen Financial Systems: Ensure stable, transparent, and accessible financial systems for businesses and individuals.
Invest in Education and Skills: Improve education and vocational training to align skills with market demands.
Develop Infrastructure: Invest in projects to facilitate economic activities, attract investments, and connect rural areas to markets.
Address Corruption and Governance: Implement measures to curb corruption, ensuring transparent governance.
Implement Social Programs: Alleviate poverty, improve healthcare, and enhance human development indices.
Ensure Fiscal Responsibility: Manage public debt, control inflation, and ensure sustainable economic growth.
International Collaboration: Partner with international organizations for financial and technical assistance while safeguarding sovereignty and long-term interests. These measures, implemented strategically with a long-term vision, can bolster Malawi's economic resilience, and foster sustainable growth.
*James Woods, a Malawi national, former diplomat to the European Union and Partner at Rainbow Sports Global. A University of Oxford MBA candidate with extensive public and private sector experience. James is also an Archbishop Desmond Tutu Fellow
