1. MONETARY AND EXCHANGE RATE POLICIES IN MALAWI Presented by Charles S.R. Chuka Governor, Reserve Bank of Malawi “Toward More Inclusive Growth” Conference Lilongwe, November 2-3, 2012

2. Outline Introduction Evolution of Monetary and Exchange Rate Policies Recent Monetary and Exchange Rate Policies changes Policy Challenges Outlook Conclusion 2

3. Key Points Inflation being driven by food scarcities Exchange rate instability reflects continuing liquidity overhang Monetary policy focusing on tightening M2 growth 3

4. Structure of the Economy Share of trading activities doubled 4 198019902000201020112012 Agriculture, forestry and fishing32.721.622.627.828.327.0 Wholesale and retail trade12.78.212.120.720.6 Manufacturing10.28.87.510.610.39.2 Transportation and Communication6.03.82.43.8 3.9 Financial/Professional Services6.04.44.62.1 Construction and Building5.02.71.33.23.03.5 Electricity, Gas and Water Supply1.61.50.81.5 Mining and Quarrying0.0 0.82.32.12.6

5. Agriculture and manufacturing output revised downwards 5 GDP Outturn

6. Objectives of Monetary and Exchange Rate Policies Main objective:Price and Financial Stability Other objectives: Sustainable balance of payments and economic growth Exchange Rate policy is aimed at external competitiveness 6

7. Evolution of Monetary & Exchange Rate Policies PeriodMonetary Policy Exchange Rate Policy Lending F/work Real GDP growth Inflatio n Rate 1964-1986 (Financial Repression) o Interest rate controls o Preferential lending to agricultural sector o Price control on selected commodities Fixed Exchange Rate regime Credit controls 5.07.8 1987-1993 (Financial Reforms) o 1987- deregulation of lending rates o 1988- deregulation of deposit rates o 1989-Review of the Banking Act o 1990-abolition of preferential lending rates Pegged to a basket of currencies Deregulate d lending 3.319.0 7

8. Evolution of Monetary & Exchange Rate Policies 8 PeriodMonetary PolicyExchange Rate Policy Lending F/work Real GDP growth Inflation Rate 1994-2007 (financial liberalization) o Indirect Monetary Policy instruments: Discount rate, OMO, LRR o New commercial banks entered the system o Free float o Partial deregulation of exchange controls o establishment of foreign exchange bureau o establishment of FCDA o establishment of foreign exchange market, Deregulated lending 3.230.4 2008-April 2012: liberalized financial sector) o Indirect Monetary Policy instruments: Discount rate, OMO, LRR Defacto fixed exchange Rate with administrative controls over current account transactions Deregulated lending 6.010.4 May 2012- to date; (liberalized fin. sector) o Indirect Monetary Policy instruments: Discount rate, OMO, LRR Free float with liberalized current account transactions Deregulated lending 1.620.1

9. Monetary and Exchange Rate Policy Framework & Instruments Reserve Money Programming (NDA + NFA) – Discount Rate – Open Market Operations – Foreign Exchange Operations – Liquidity Reserve Requirements – Moral Suasion/Signalling Exchange rate regime: Managed Float 9

10. M2 managed through reserve money 10 M2 and Reserve Money

11. Lending rates and M2 11 Low real lending rates pushing M2

12. Domestic Credit Developments 12 Domestic credit declining

13. Inflation Driven by Food Prices 13

14. Inflation Sources Source: National Statistics Office Manage food prices

15. Money Supply & Inflation 15 M2 impact on inflation unclear (Long lag?)

16. Sources of M2 Growth 16

17. Exchange Rate and Inflation 17

18. Impact of Fixed Exchange Rate Policies Loss of foreign exchange reserves Import backlog accumulated Fuel scarcity Downsizing by companies GDP growth was reducing 18

19. Recent Policy Reforms Exchange Rate floated May 2012 Bank rate was adjusted upwards twice-May and July 2012 Fuel pricing is now based on Automatic Pricing Mechanism 19

20. Recent Policy Reforms (cont’d) RBM sold about US$220 million between May and August 2012 compared to US$37.7 million sold in similar period in 2011 Tobacco proceeds re-routed through commercial banks RBM provided liquidity to stressed banks 20

21. 21 Recent Policy Reforms (cont’d)

22. 22

23. 23 Recent Policy Reforms (cont’d)

24. Exchange Rates: Commercial and Bureau rates 24 Commercial Banks and Bureau rates are now converging Recent Policy reforms, cont’d

25. Gross Official Reserves (GOR) Gross Official Reserves started to improve in July 2012 25 Recent Policy reforms, cont’d

26. Policy Reforms (Cont’d) 26

27. Challenges Containing M2 growth at current levels will depend on successful rollover of domestic debt Monetary policy space is declining Pressure on exchange rate is likely to persist due to seasonal factors Limited supply of foreign exchange M2 growth is slowing down but inflation is rising 27

28. Lessons Inflationary pressures remain GDP growth still positive Exchange rates aligned 28

29. Outlook Foreign exchange shortages are envisaged to persist as seasonally expected Given the obtaining macroeconomic fundamentals, there is need to tighten further monetary policy or maintain the current tight stance. 29

30. Conclusion Given the current macro-scenario, threats of inflation pressures still persist. The question is to what extent can monetary policy still tighten without severe adverse effects on the economy? 30

31. Thank You 31