A. Appendix
A.5 The presence of fat tail confirm heteroscedasticity of the GARCH process
5. Conclusions and recommendations
Market power effects tend to offset the volatility nature of exchange rate, hence it can positively affect investments.
The panel ARDL results in Table 5 confirm that lending rates are positively related to investment in the short run at a 1% level of significance. Money supply and exchange rate, on the other hand, showed no significant short-run relationship with investment (Table 5). Most importantly, the error correction term met the requirement of being negative and is very high at 83% and significant at 5% level.
This implies that investment will be very fast to go back to equilibrium following a change in the selected monetary variables. These results are valid and reliable as mentioned in Nkoro and Uko [60] that panel ADRL has Gaussian error terms implying normal distribution, no autocorrelation and no heteroscedasticity in error terms.
Author details
Ombeswa Ralarala and Thobeka Ncanywa*
Department of Economics, University of Limpopo, Sovenga, South Africa
*Address all correspondence to: [email protected]
© 2020 The Author(s). Licensee IntechOpen. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/
by/3.0), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.
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Will Malawi ’ s Inflation Continue Declining?
Hopestone Kayiska Chavula
Abstract
The main objective of this chapter is to examine and determine the main factors that have driven inflation rate in Malawi since 2001, with a special focus on the period 2013–2019, during which inflation rate has continuously declined reaching 9% in 2019, from 36% in 2013. The chapter also tries to assess whether this decline will continue as per the performance of the underlying economic fundamentals both in the short- and the long-run. The study employs the autoregressive distrib- uted lag (ARDL) model framework to examine the drivers of inflation both in the short- and the long-run using quarterly data, over the period of 2001–2019. The results reveal that reduction in headline inflation has mainly been driven by money supply growth, fiscal deficits, and output growth in the short-run, while only output has driven inflation decline in the long-run. The results also show that after floating exchange rate in 2012, inflation decline has mainly been driven by output growth despite inflationary pressures from the exchange rate and import prices.
Model forecasts show that inflation may increase up to 19.4% by December 2020, if money supply growth, fiscal deficits, and exchange rate movements are not taken care of.
Keywords:monetary policy, ARDL, unit root, co-integration, forecasts
1. Introduction
Malawi is a small country located in the Southern part of Africa, with a surface area of 118,484 square kilometres, total length of 853 km and a maximum width of 257 km. It is a former British colony that gained independence in 1964. Its economy is mainly dependent on agriculture which employs about 65% of the workforce in the country, and contributing about 36% to the economy’s gross domestic product (GDP). More than 90% of the country’s export revenues come from the agriculture sector. The sector is one of the main contributors to the country’s building of inflationary pressures as it occupies the largest proportion of the country’s inflation basket designed by the country’s National Statistical Office (NSO).
High inflation and fluctuation in prices is not preferred as it leads to uncertainty and cost push shocks which affect the stability and performance of economies [1].
This being the case, maintaining relatively low inflation and price stability has been one of the core objectives targeted by the monetary authorities in designing and implementing monetary policy in Malawi. Before 2012, Malawi operated a de facto pegged exchange rate regime with periodic devaluations. The national currency was pegged to the US dollar and kept an overvalued exchange rate. However, in 2012 Malawi implemented a floating exchange rate regime where prices and exchange
rates move based on economic fundamentals [1]. During the same period, the country adopted an automatic fuel pricing mechanism, which together with the newly implemented floating exchange rate regime was aimed at addressing the country’s balance of payments problems.
As has been the case with most developing countries in Africa, the main objec- tive of the monetary policy in Malawi has been to achieve low and stable prices that preserve the value of the Kwacha (the local currency), and encourages investment needed to achieve sustainable economic growth and create employment as stipu- lated in the Reserve Bank of Malawi Act of 1989 [2]. This is because price stability enhances investors’confidence as it reduces uncertainty in an economy and, thereby creating a favorable environment for growth and employment creation.
Furthermore, low inflation contributes to the protection of the purchasing power of all households, particularly the poor who have no means of defending themselves against continually rising prices. However, the implementation of such a broad mandate could be practically challenging, since some of the policy objectives could be in conflict with each other [3]. Nonetheless, monetary policy pursued by most developing countries has managed to bring down inflation over the past two decades, with significant growth being experienced in most countries in the past decade or so [4].
In Malawi, monetary policy implementation continues to be underpinned by inflation dynamics especially by the dominance of the agricultural sector activities and the country’s reliance on donor funding which contributed about 40% of the country’s budget before the“Cash-gate scandal”1which led to withdrawal of donor funding in 2013. With the economy’s dependence on agriculture, inflation in Malawi normally improves with improved food availability and tobacco sales, mostly from April to September every year. It then accelerates with food scarcities and excessive demand for foreign exchange from October to March [5]. However, it is claimed that the country’s monetary policy does not seek to address these
dynamics but rather to achieve a balance between output growth and monetary aggregates as well as smoothening of exchange rate movements. With the belief that these inflation dynamics will improve over time as production structures respond to macroeconomic stability in the context of a market-determined exchange rate [2]).
Figure 1shows that interest rates reached as high as 52% in 2000, mainly driven by increased deficit financing as the IMF stopped aid disbursements due to corrup- tion concerns in December 2000, and many individual donors followed suit,
resulting in an almost 80% drop in Malawi’s development budget. The continued deficit financing led to an increase in liquidity in the economy, exerting pressure on both interest rates and domestic prices. Since then both interest rates and inflation declined significantly due to improved fiscal management and increased real growth, with interest rates, inflation, money supply and GDP growth averaging 24.3%, 10.9%, 1.9% and 6.3% respectively over the period 2005–2009.
However, since 2005, Malawi enjoyed price stability as inflation declined from 16% to 7.2% in March 2011. Overall, inflation remained moderate and in single digits since 2007, mainly due to a relentless adherence to a tight monetary policy, heavily buttressed by fiscal discipline and stable exchange rate up-to January 2012 when it jumped to 10.3% (Figure 1). However, inflation remained persistently high since 2012, mainly due to the country’s switch from a fixed to a floating exchange rate regime, which led to a sharp depreciation of the exchange rate which was further exacerbated by the withdrawal of external budget support following the
1 “Cashgate”is a financial scandal involving looting, theft and corruption that happened at Capital Hill the seat of Government of Malawi.
large scale theft of public funds coined the“cash-gate scandal”. These developments exerted inflationary pressures in the economy, with inflation hovering to as high as 37.9% by February 2013, mainly driven by food prices, especially maize prices following poor agricultural performance and depreciation of the exchange rate [2].
Furthermore, financing of the fiscal deficits in the aftermath of the scandal was done through printing of money and the issuing of government securities to the private sector. In addition, the economy suffered from the effects of a combination of droughts and floods resulting in a reduction in agricultural production leading to a sharp increase in food inflation [1].
During this period, in May 2012, the exchange rate depreciated by 49% against the major currencies leading to a significant increase in inflation rate. As a conse- quence, interest rates increased to contain the inflationary pressures induced by the depreciation of the local currency, and also to contain inflationary expectations pressure accumulated over the preceding period. Furthermore, apart from the inflationary expectations arising from the continued uncertainty in the exchange rate policy, increasing food prices, especially maize prices, exacerbated the situation [2]. Inflation rates, interest rates and nominal exchange rates reached their highest levels over the period May 2012 to May 2013. Rising as high as 38%, 41% and 355 Kwacha per US/$ respectively, the highest levels after a long time.Figure 1 shows that after this period both inflation and interest rates begun to decline, while the exchange rate continued to depreciate.
Continued exchange rate depreciation and relatively tight monetary policy have further resulted into inflationary pressures, exacerbated by the substantial increase in government domestic borrowing due to donor suspension of direct budget support to the Malawi Government due to the Cashgate scandal [2]. This raised domestic financing requirements by government, hence creating more liquidity in the economy. This also heightened pessimistic inflation expectations by the public and precipitated exchange rate depreciation. These developments led to an increase in money supply growth and inflation [2]. It should also be noted that despite the continued decline in the global oil prices during the period, its impact has not fully been translated into the Malawian economy because the automatic pricing mecha- nism on energy prices adopted since 2012 has not consistently been reflecting this decline [2]. Food prices especially maize during the harvesting seasons were also not
Figure 1.
Inflation, exchange rate and interest rate dynamics, January 2001–June 2019. Source: [6].
significantly declining to have an impact on inflation during the period January 2013 to February 2016. However, inflation in Malawi has continued to decline since early 2013, declining by 29 percentage points from 36% in February 2013 down to 9% in June 2019 (Figure 1). This is despite the theoretical economic fundamentals behaving to the contrary as fiscal balances widened from 1.9% of GDP in 2011 to
7.2% in 2018; and the country switched from a de facto pegged exchange rate regime to a floating exchange rate regime, leading a 33% devaluation of the local currency in 2012. Authorities’adoption of the automatic fuel pricing mechanism during the period meant that fuel prices should reflect the recent increases in global fuel prices. However, on the contrary, money supply grew at an average of 1.6%
between February 2013 and September 2019, while policy rate declined from 25% in 2013 to 13.5% in 2019, theoretically easing the inflationary pressures in the economy.
Since Wu [1], there has been no study (to the author’s knowledge) that has looked at inflation dynamics in Malawi over the period 2000–2019 as carried out in this study. However, the most recent study by Wu [1] focused mainly on the period up to 2015, investigating mainly the effects of the exchange rate regime change in 2012 and the switch to an automatic fuel pricing mechanism. This study, however, focuses on a relatively much longer period investigating the factors behind inflation movements in Malawi noting that a number of policy and structural changes have taken place over the period 2000–2019, which might not have been fully captured by Wu [1]. Authorities claim that most of these policy and structural changes have contributed to the recent continuous decline in headline inflation in the country.
The main objective of this chapter is therefore to examine the factors that have led to inflation movements in the Malawian economy with a special focus on the recent continuous decline, and assessing whether it is a reflection of the performance of the country’s economic fundamentals and whether it is something that will persist in the short to medium term.
The rest of the chapter is organized as follows. The next presents a brief litera- ture review of some previous studies in the area. Section 3 presents the methodol- ogy employed in the chapter, while Section 4 presents the results of the analysis and Section 5 concludes the chapter.
2. Literature review
A number of studies have looked at the effectiveness of monetary policy in Malawi or the effect of selected monetary policy variables on the economy, but very few (if any) have focuses on inflation in the past few years. For example, Wu [1]
looked at the causal relationship between food and non-food inflation in Malawi before examining the exchange rate pass-through process to headline inflation and how it has evolved during the pre- and post-exchange rate regime change in 2012.
The paper further investigates the possible drivers of headline inflation in Malawi over the period 2001–2015 [1]. However, the period 2012–2015 could not have offered longer enough time horizon for the exchange rate policy regime change implemented in 2012 to have had a significant impact on inflation. This study, with a much longer time span, covering the period 2012–2019, is expected to provide more insights on the impact of both structural and policy changes on inflation in the country. Ngalawa and Viegi [7] uses the structural vector autoregressive model to investigate the transmission mechanism through which monetary policy affects domestic prices and output growth in Malawi. The results of the study reveal that the bank rate remained a more effective measure of monetary policy than reserve money over the period of the study. The results also support the narrative that price