December 18, 2011IMF squeezes Malawi to free Kwacha currency
The International Monetary Fund (IMF) has minced no words but directed the Malawi government to institute a liberalized exchange rate regime as a way manage the overvauled local currency, the Kwacha.
This is contained in a report titled ‘Liberalization of the foreign exchange regime for current account transactions and exchange rate flexibility’ on Malawi by IMF’s Mission chiefs Etibar Jafarov, Nadia Rendak and Kelly Eckhold with Morten Jonassen Norges Bank.
The report obtained by Nyasa Times says Malawi continues to have a severe shortage of foreign exchange in the context of an overvalued official exchange rate and tight administrative regulations designed to force economic agents to trade at these levels.
“The administrative measures are increasingly difficult to implement and a significant share of trade has moved to the parallel market. The loose monetary and fiscal policies have significantly exacerbated the situation. The mission recommends a fast but staged liberalization of the current regime and formulated specific reforms to achieve this,” the IMF says.
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The IMF mission says it believes the recommendations must be implemented quickly, starting first with reversing the recent loose macroeconomic policies since unnecessary delays could further exacerbate the current situation.
The mission said further devaluation must be implemented within 3 months and all restrictions on forex transactions must be listed shortly after that so that the Reserve Bank of Malawi (RBM) should deregulate the forex market.
They noted that private sector contacts pointed to adverse effects of the current regime. In particular, the current regime not only hurts exporters, but also production and employment in general, as the chronic forex shortage has led to reduced imports of raw materials, fuel, spare parts, and other critical imports.
The say anecdotal evidence suggests that market players try to avoid these restrictions through under-invoicing, barter trade, side payments, and other similar activities.
“The authorities generally acknowledge the need to move to a liberalized exchange regime, but prefer to move gradually and guide market prices through mechanism such as an exchange rate band,” say the IMF.
They argued that low levels of reserves, the damage made to the credibility of the authorities by the loose macroeconomic policies and the authorities’ track record in the area of the forex regime have rendered any peg-like regime such as a band not credible at the moment.
The mission provided advice in preparation for a quick but staged process towards more exchange rate flexibility. In this context, the authorities were advised to immediately start implementing tight monetary and fiscal policies and reduce the liquidity overhang, created in July-October, through issuing short- and long-term instruments.
IMF says this should be followed by a large devaluation, an announcement of the intention to operate freely floating exchange regime, removal of restrictions on forex bureau rates, and setting the official rate with reference to traded markets.
The mission acknowledged that there are significant risks of illiquidity in the development stages of the market as there is significant excess demand for forex formed under the current regime.
It says in the transition process, the RBM could help the forex price discovery process through a daily 2-way auction or a so-called market fixing session, with information on these transactions fully disclosed.
Once floating is achieved, the RBM should be prepared to be a price taker on the forex market and transact with banks only, as opposed to dealing with exporters and importers directly so that in the medium term, the RBM should deregulate the forward forex market.
The mission stressed the need to improve risk management practices at banks and take prudential measures to deal with risks related to exchange rate volatility under the new regime and to maintain the stability of the financial system.
In this regard, the mission was encouraged by recent progress in building the RBM’s capacity in stress testing, with help from technical assistance under the IMF, Norges Bank, and RBM technical assistance project aimed at modernizing the operations of the RBM.
“Changes to forex regulations will be required to operationalize the liberalized regime. While concrete recommendations would depend on the policy choices made by the authorities, the mission formulated some of the key features of the reformed framework,” the IMF says.
They stress that all the proposals come from the talks they had with Minister of Finance and Development Planning Ken Lipenga, RBM Governor Perks Ligoya with many other senior government officials.
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