Reserve Bank of Malawi decision on bank rate makes sense: ‘Cut the chaff’

In Weekend Nation newspaper, popular columnist  Ephraim Munthali of the  ‘Cut the chaff‘continues to critique President Joyce Banda on economic issues. Here if the full articled as it appeared:

I was not surprised to read on Thursday that the Monetary Policy Committee (MPC) of the Reserve Bank of Malawi (RBM) has for the third time since December 2012 maintained the benchmark bank rate at 25 percent.

The move could be surprising to some for one major reason: headline inflation. The National Statistical Office (NSO) recently announced that year-on-year inflation rate for March 2013 was 36.4 percent.

This was a decrease of 1.5 percentage points from February and is largely attributable to a drop in food prices, which fell from 30.2 percent to 27.7 percent.

With farmers in the middle of the harvest period, food prices—which control 50.2 percent of the Consumer Price Index—are declining and should continue to do so, at least over the next quarter.

Charles Chuka: RBM governor

Charles Chuka: RBM governor

Then there is the small matter of fuel prices that have stabilised over the past couple of months.

In fact, this week, government announced that diesel and petrol prices would drop by around 2.5 percent as the Automatic Pricing Mechanism (APM) in April swung in favour of the consumers.

The good news on fuel prices, coupled with falling food costs, should further dampen the general rise in prices, help improve the inflation outlook and give some people reason to expect downward movements in interest rates.

These are legitimate expectations and understandable, except for two things. First, core inflation—which excludes the volatile food and fuel prices—has been rising steadily over the past few months.

Just in March, NSO reported that core inflation increased from 37.6 percent to 37.9 percent, which signals a long-term inflation problem that may not be tamed in a hurry.

Besides, while inflation is expected to moderate after the staple grain maize harvests that began last month, there are lagging effects that could turn the inflation slow-down into a long slog.

Second, and I think the most important reason the central bank will not move any time soon to hike the bank rate, is the exchange rate.

It is clear that stabilisation of the kwacha exchange rate is the main economic and political imperative at the moment, more so for the latter given that the 2014 tripartite elections are less than 12 months away and the administration is loathe to its devastating cost-push effects on import-dependent Malawi.

Reducing the bank rate now—which would result in reciprocal cuts in base lending rates that commercial banks charge borrowers—may have a reverse impact in that it could lead to the depreciation of the kwacha.

This is because ordinarily, policy decisions to lower interest rates are usually made to maintain a relatively depreciated currency.

In other words, those of us who are demanding a low interest rate regime must be prepared to accept a relatively weak kwacha, which is politically difficult at the moment.

Keeping interest rates high to help stabilise the kwacha is a tough trade-off, especially because of the move’s potential threat to economic recovery.

The interest rate gamble also needs the support of an even tighter fiscal policy for it to work and, with luck, later force banks to reduce their interest rates as government cuts its borrow and spend appetite to help suppress demand for credit and allow wealth creators to access loans.

Moreover, with the political leadership constantly on the podium to tout the appreciation of the kwacha as a sign that the Economic Recovery Plan (ERP) is working, I am left in no doubt what the administration’s policy goal is: keep the kwacha steady and, better still, let it appreciate.

So, yes, the kwacha exchange rate will continue to be market-determined. But be assured that the central bank will be intervening, albeit at a limited scale for purposes of meeting the net international reserve target and moderating seasonal fluctuations.

What the RBM will not do is to try and influence underlying trends lest they breach the agreement with the International Monetary Fund (IMF) whose views have a psychological effect on the money market (and movements in the local exchange rate) and development partners’ willingness to release balance of payment support, which is also critical to the local currency’s stabilisation.

In my view, the RBM hopes that higher interest rate differentials can help attract capital flows—albeit at a small scale—from international investors who, lured by our high interest rates, may want to transfer their dollars into our financial system and buy the high yielding assets such as bonds and treasury bills, thereby bringing forex that can in a small way help lead to the kwacha’s appreciation.

The RBM will try anything now to strengthen the kwacha as safely (in relation to IMF agreements) as possible and high interest rates are a rough but convenient tactic, especially when we know that the country’s current account balance and net external flows are in no shape to sustain a puffed up kwacha.

Vote Of Thanks

I doubt that my vocabulary is rich enough with words that can best describe my gratitude to fellow journalists for choosing Cut the Chaff and its readers for the ‘Columnist of the Year Award.’

I have added my readers because without them, this space would be an orphan. My fellow professionals’ kindness and my readers’ generosity with their time to appreciate my thoughts and how I present them inspire me to better myself given that I did not win because I am the best (there are several columnists I respect), but rather because someone had to get the award and I happened to be the lucky one this year.

Once again, thank you.

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