MONETARY AND EXCHANGE RATE POLICIES IN MALAWI

Presented byCharles S.R. Chuka

Governor, Reserve Bank of Malawi

“Toward More Inclusive Growth” ConferenceLilongwe, November 2-3, 2012

Outline• Introduction• Evolution of Monetary and Exchange Rate

Policies

• Recent Monetary and Exchange Rate Policies changes

• Policy Challenges • Outlook• Conclusion

2

Key Points

• Inflation being driven by food scarcities

• Exchange rate instability reflects continuing liquidity overhang

• Monetary policy focusing on tightening M2 growth

3

Structure of the Economy

Share of trading activities doubled

4

  1980 1990 2000 2010 2011 2012

Agriculture, forestry and fishing 32.7 21.6 22.6 27.8 28.3 27.0

Wholesale and retail trade 12.7 8.2 12.1 20.7 20.6 20.6

Manufacturing 10.2 8.8 7.5 10.6 10.3 9.2

Transportation and Communication 6.0 3.8 2.4 3.8 3.8 3.9

Financial/Professional Services 6.0 4.4 4.6 2.1 2.1 2.1

Construction and Building 5.0 2.7 1.3 3.2 3.0 3.5

Electricity, Gas and Water Supply 1.6 1.5 0.8 1.5 1.5 1.5

Mining and Quarrying 0.0 0.0 0.8 2.3 2.1 2.6

Agriculture and manufacturing output revised downwards

5

GDP Outturn

Objectives of Monetary and Exchange Rate Policies

• Main objective:Price and Financial Stability

• Other objectives: Sustainable balance of payments and economic growth

• Exchange Rate policy is aimed at external competitiveness

6

Evolution of Monetary & Exchange Rate Policies

Period Monetary Policy Exchange Rate

Policy

Lending

F/work

Real GDP

growth

Inflatio

n Rate

1964-1986

(Financial

Repression)

o Interest rate controls

o Preferential lending to agricultural sector

o Price control on selected commodities

Fixed Exchange Rate

regime

Credit

controls

5.0 7.8

1987-1993

(Financial

Reforms)

o 1987-deregulation of lending rates

o 1988-deregulation of deposit rates

o 1989-Review of the Banking Act

o 1990-abolition of preferential lending rates

Pegged to a basket of

currencies

Deregulated

lending

3.3 19.0

7

Evolution of Monetary & Exchange Rate Policies

8

Period Monetary Policy Exchange Rate Policy Lending

F/work

Real

GDP

growt

h

Inflation

Rate

1994-2007

(financial

liberalization)

o Indirect Monetary Policy instruments: Discount rate, OMO, LRR

o New commercial banks entered the system

o Free floato Partial deregulation of

exchange controlso establishment of foreign

exchange bureauo establishment of FCDAo establishment of foreign

exchange market,

Deregulated

lending

3.2 30.4

2008-April

2012: liberalized

financial sector)

o Indirect Monetary Policy instruments: Discount rate, OMO, LRR

Defacto fixed exchange Rate with administrative controls over current account transactions

Deregulated

lending

6.0 10.4

May 2012- to

date;

(liberalized fin.

sector)

o Indirect Monetary Policy instruments: Discount rate, OMO, LRR

Free float with liberalized current

account transactions

Deregulated

lending

1.6 20.1

Monetary and Exchange Rate Policy Framework & Instruments

• Reserve Money Programming (NDA + NFA)–Discount Rate–Open Market Operations–Foreign Exchange Operations–Liquidity Reserve Requirements–Moral Suasion/Signalling• Exchange rate regime: Managed

Float

9

•M2 managed through reserve money10

M2 and Reserve Money

Lending rates and M2

11Low real lending rates pushing M2

Domestic Credit Developments

12

Domestic credit declining

Inflation Driven by Food Prices

13

Inflation Sources

Source: National Statistics Office

Manage food prices

Money Supply & Inflation

15

M2 impact on inflation unclear (Long lag?)

Sources of M2 Growth

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Exchange Rate and Inflation

17

Impact of Fixed Exchange Rate Policies

• Loss of foreign exchange reserves• Import backlog accumulated• Fuel scarcity• Downsizing by companies• GDP growth was reducing

18

Recent Policy Reforms

• Exchange Rate floated May 2012• Bank rate was adjusted upwards

twice-May and July 2012• Fuel pricing is now based on

Automatic Pricing Mechanism

19

Recent Policy Reforms (cont’d)

• RBM sold about US$220 million between May and August 2012 compared to US$37.7 million sold in similar period in 2011

• Tobacco proceeds re-routed through commercial banks

• RBM provided liquidity to stressed banks

20

21

Recent Policy Reforms (cont’d)

Recent Policy Reforms (cont’d)

22

23

Recent Policy Reforms (cont’d)

Exchange Rates: Commercial and Bureau rates

24

•Commercial Banks and Bureau rates are now converging

Recent Policy reforms, cont’d

Gross Official Reserves (GOR)

Gross Official Reserves started to improve in July 2012

25

Recent Policy reforms, cont’d

Policy Reforms (Cont’d)

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Challenges

• Containing M2 growth at current levels will depend on successful rollover of domestic debt

• Monetary policy space is declining• Pressure on exchange rate is likely to persist

due to seasonal factors• Limited supply of foreign exchange• M2 growth is slowing down but inflation is

rising

27

Lessons

• Inflationary pressures remain• GDP growth still positive• Exchange rates aligned

28

Outlook

• Foreign exchange shortages are envisaged to persist as seasonally expected

• Given the obtaining macroeconomic fundamentals, there is need to tighten further monetary policy or maintain the current tight stance.

29

Conclusion

• Given the current macro-scenario, threats of inflation pressures still persist.

• The question is to what extent can monetary policy still tighten without severe adverse effects on the economy?

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Thank You

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