The Economic Challenges facing Malawi’s New President

Malawi’s third president, the late Bingu Wa Mutharika had a fairly successful first term in office from 2004-2009. During this period, Malawi’s economy grew at an average of 6.5 percent and average inflation remained below 12 percent, compared to about 2 percent growth and 35 percent inflation over the preceding decade. Additionally, exports as a percentage of GDP grew enabling Malawi to accumulate substantial foreign reserves, which helped minimize volatility in the country’s currency (the Kwacha). On the whole, Malawi increasingly became a net food exporter and significantly improved its infrastructure. To some degree, this good economic performance resulted from the positive relations the president cultivated with donors. For example, debt relief under the Heavily Indebted Poor Countries (HIPC) program with the World Bank/IMF in 2006 was concluded and a multi-million dollar exogenous shock facility (ESF) was extended by the IMF. Also, in December 2007, Malawi became eligible to receive financial support from the U.S. under the Millennium Challenge Corporation (MCC) initiative.

Despite these gains, President Mutharika’s second term in office was very disappointing due to a series of economic flops and the general mal-governance of the country. Amongst the several economic woes were the rising cost of living, the acute shortage of fuel and power, and increased black market foreign exchange premiums. Until his death, and in contradiction to IMF advice, Mutharika resisted further nominal devaluation of the Kwacha, which had undergone a moderate depreciation between 2009 and 2011. Added to these economic malaises was the systematic violation of human rights, Mutharika’s increasingly autocratic leadership style and his fiercely antagonistic relationship with donors.

The challenge facing Malawi’s new interim president, Joyce Banda, is to find the right combination of policies that will put the country back on a path for sustainable growth. One such approach is to systematically undo the several “policy follies” of Mutharika’s second term. In particular, President Banda could pursue a more contractionary monetary policy given the current environment of high inflation. This would help mitigate further declines in foreign exchange reserves, although it would also come at the cost of lower output and employment in the short run. President Banda’s government will also need to downsize domestic public borrowing (a principal source of loss in foreign reserves), review current tax laws to alleviate its burden on the poor and progressively phase out exchange controls.

However, one should make no mistake, there are no quick fixes to the problems currently facing Malawi and an appraisal of the political economy of macroeconomic policies during Mutharika’s second term is vital to President Banda’s success. Malawi is a landlocked, agriculture-dependent economy that derives a significant portion of its foreign exchange from the export of tobacco. With steady foreign demand, Malawi’s reserve holdings were projected to grow from $137 million in 2009 to $521 million in 2011. However, due to the global financial crisis and continued eurozone instability, demand for Malawi’s tobacco plummeted by nearly 80 percent in the first quarter of 2011, resulting in a drastic decline in Malawi’s foreign exchange reserves.

Malawi, like other resource-poor sub-Saharan African economies, is heavily dependent on donor aid, which accounted for almost a third of government revenues over the past five years. However, since June 2011, Britain and the larger international donor community have suspended aid and other programs following concerns about poor governance. Notably, the IMF has suspended a $79 million aid facility because of the government’s failure to undertake crucial economic reforms including further devaluation of the Kwacha.

At the root of Malawi’s currency problems has been the systematic decline in foreign exchange reserves, which was caused by two main factors: increased domestic public borrowing and adverse external demand shocks. Either a reduction in public borrowing or an ESF loan from the IMF would have mitigated further decline in foreign reserves and stabilized the Kwacha, however Mutharika and the IMF disagreed on which approach to take. Mutharika insisted that an IMF loan was the best option while the IMF instead pointed to the need to reduce domestic public borrowing. Frustrated with his failure to obtain external financing to support the exchange rate, Mutharika resorted to capital controls to limit the drain on foreign reserves, which only amplified the currency misalignment. Faced with reduced budgetary resources, Mutharika’s government was left with few options other than to impose higher taxes on basic consumer goods such as milk and bread. The higher taxes led to increased cost of living, which in turn fueled uprising and feelings of general discontent with the government. As this standoff demonstrates, a sustainable solution to Malawi’s economic challenges rests not only with the Malawian government but also with the donor community. An important lesson for Malawi and other resource-poor, aid-dependent, small open economies is that healthy relations with donors affect the strategic choice and implementation of optimal economic policies.

Happily, President Banda seems to have correctly understood this message and has started easing Malawi’s tense relationship with donors. Over and above any potential donor assistance, Banda’s government must also implement the domestic policies outlined earlier; otherwise any action on the part of the international donor community will be futile. Similarly, the donor community and particularly the IMF/World Bank should make resources available for budgetary support and stabilization of the exchange rate to bolster the actions of the Malawian government. In the short run, further nominal devaluation of the Kwacha would be counterproductive especially as previous nominal depreciations have not been followed by a real depreciation and the country’s domestic debt is mostly denominated in foreign currency. One can only hope that joint action by the aid community and President Banda will turn Malawi’s economy around.