To devalue or not to devalue the Kwacha, that's the question

A week after the old man had gathered his party faithfuls at New State House (is it still new, by the way?) to lecture them on the economy among other things, some of us gathered in a virtual lecture hall to hear Frank Chantaya argue why floating the Kwacha would be a good thing for the Malawi economy.

Here is his lecture, which he titled 'HOW A FIXED RATE IS KILLING THE GOOSE THAT IS LAYING THE GOLDEN EGG'.

[interruption by Yuen Chikando] "I bet the question should be posed, what is in an exchange rate?, what shuld determine it, the market, the executive order, the growth variables?"

[interruption by Marcus Aurellius] "Yuen, all the variables you have mentioned play a role."
Frank Chantaya: "An exchange rate is effectively the price at which you buy the currency of another country in order to purchase foreign goods or services. In simple terms, therefore, an exchange rate issue is practically about the pricing of foreign currency.
The major suppliers of foreign exchange in Malawi are tobacco farmers, including companies such as Limbe Leaf, Alliance One, etc. This list goes on to include cotton farmers, companies, sugar producer Illovo, recently Uranium exports from Kayerekera. Until recently, this list would have included the donor community, IMF and World Bank and the African Development Bank. Malawians who offer their services in foreign countries also bring in forex when they remit back to their homes, though this is at a small scale. Tourism, especially the hotel industry and lake shore resorts also rake in some forex.

The major suppliers of forex are therefore tobacco, tea, cotton, sugar, uranium and donor budgetary support."

[interruption from
Yuen Chikando] "You should have started your statement with: "The major suppliers of forex are therefore donor budgetory support, tobacco in that order" just to give prominence to the weighting of their contribution. As an ex RBM man  you should be privy to that."
Frank Chantaya: "When an Illovo, for example, exports sugar, the price they get per dollar is K150 to the dollar. But in order to produce 1 kg of sugar Illovo requires many types of inputs which are supplied by local traders. Most of these traders access their foreign currency at the parallel market and build in the cost of the higher exchange rate when selling their products to Illovo. Unfortunately, Illovo cannot transfer this cost to the final consumer of sugar as their dollar rate is fixed.
Results for year ending 31st March 2011 reveal that revenues for this forex generator went down by K1 billion. The reason for the drop being that while their costs were increasing, there was no corresponding increase in revenues due to the fixed exchange rate.

In reaction, Illovo has suspended their plans to expand their production of sugar, a project estimated at $300 million, because the operating terrain in terms of the exchange rate does not support them.

Effectively, those who access foreign currency through the formal system are heavily subsidised by a government enforced fixed exchange rate, while these good guys who are generating the foreign exchange pay the price for getting less Kwacha for their dollar.

As a result key industries such as sugar, tea and cotton are progressively losing value over time because they cannot catch up with escalating costs while the revenue is restricted by a fixed exchange rate. The story is the same with the tobacco companies who have now tightened their purses as they are also short changed with a fixed exchange rate while the other costs built into their overheads reflect the higher parallel market exchange rate.

Secondly, those of you who have studied purchasing power parity, PPP, will agree that in relative terms, because of an artificially strong exchange rate Malawi tobacco is more expensive than Zambian tobacco. That in itself is self defeating because our competing neighbours will be able to attract customers that we cannot due to the higher price.

Zambia for example has no forex issues or fuel issues whatsoever. Its exchange rate is at ZK4800 to the dollar while we are at MK150 to the dollar. Yet Zambia is able to generate sufficient forex appropriately priced to reward those who generate it.

An appropriate exchange rate would encourage huge investors such us Illovo and tea companies to inject more into the economy and produce more dollars while a fixed exchange rate discourages them from doing.

Interestingly, because our cars are artificially cheap, users of forex are enjoying a forex haven and are as a result flooding (almost dumping) our economy with everything that anyone from outside our boarders can produce, including toothpicks. The simple variable that is driving this human behaviour (cheap dollar), favours the users of forex and not the generators.

Ladies and gentlemen, it is clear from this lecture that Malawi, as opposed to China, does not have the muscle to support a fixed exchange rate."

[interruption from
Harry Caetano] "Are you aware that our country has become a dumping place for foreign goods? What measures have you put forward to control such behaviours to sustain our economy?"
Frank Chantaya: "Unfortunately, I do not have the powers to put any measures in place. All the same I can propose to those who are in policy making positions that one of the solutions is, of course, exchange rate adjustment but combined with other policy measures such as heavily taxing those goods heavily to discourage the unsustainable appetite for them."

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