To devalue or not devalue: that is the question.

To devalue or not to devalue: that is the question. For years the World Bank and the IMF have simply pushed devaluation to solve balance of payment problems. That has often been too easy an one-size-fits all solution to a complex question. There are often two conflicting objectives around the exchange rate. On the one hand there is the concern for economic stability to encourage investment to ensure economic growth. Devaluations can inject an element of uncertainty in the economy that often discourages investors. This hurts the long term growth prospects of the economy. On the other hand there is the need for flexibility and competitiveness. A stable but overvalued currency will discourage exports while encouraging imports. This may lead to serious balance of payments problems that would, in turn, undermine confidence in the economy and eventually undermine investment.

The President has evoked the “economic stability/investment” argument and we believe he has his priorities right. Experience with the massive devaluations of the 1980s is that they did not lead to the expected export booms and instead simply contributed to great volatility. This undermined investment and destroyed export capacity. Competitiveness based on devaluations is not sustainable and too much focus on manipulating the exchange rate to promote exports may detract attention from the more useful path of gaining competitiveness through improved productivity.

In all this there is the unresolved question in the direction of causation. Is it investment that leads to greater export or is export that stimulates investment? If the former is the case, then Bingu’s point stands and if the latter is true than those arguing for devaluation have a point. Economists are not agreed on this. The best one can say is that the policy makers will have to decide on the basis of what they know to be the causal direction in their respective countries. There does seem, however, to be a strong case for the invest-growth-export sequence. In any case the many drivers of Malawi’s current growth – investment in mining, infrastructure and technology-driven telecoms are not desperately in need of devaluations.

Where Bingu is wrong is in his swearing that he will never devalue the Kwacha. That is a little disingenuous and not credible. He would be better advised to state that the government’s reading of the current situation is that the stability argument is the more appropriate one for the economy and that the government will make the necessary correction when needed. He could argue that the government is doing everything to promote exports by improving communication to reduce transaction costs and providing seeds and fertilisers that are making Malawi a bread basket.. He will however have to contend with the fact that the country’s reserve are dangerously low and that may discourage investors.

Ultimately the smart policy is one that ensures a stable but “realistic” and competitive exchange rate that assures investors and facilitates exports. In other words the government should strive to achieve and then maintain a stable real exchange rate that is sufficient to promote a high export growth rate and cushion the country’s reserve.