Currency Trouble in Malawi Closing Case (Question below article) When the former

Question

Currency Trouble in Malawi Closing Case (Question below article)

When the former World Bank economist Bingu wa Mutharika became president of the East African nation of Malawi in 2004, it seemed to be the beginning of a new age for one of the world's poorest countries. In landlocked Malawi, most of the population subsists on less than a dollar a day. Mutharika was their champion. He introduced a subsidy program for fertilizer to help poor farmers and gave them seeds. Agricultural output expanded, and the economy boomed, growing by 7 percent per year between 2005 and 2010. International donors loved him, and aid money started to pour in from the United Kingdom and the United States. By 2011, foreign aid was accounting for more than half of Malawi's annual budget.

In 2009, to no one's surprise, Mutharika was reelected president. Then things started to fall apart. Mutharika became increasingly dictatorial. He pushed aside the country's central bankers and ministers to take full control of economic policy. He called himself “Economist in Chief.” Critics at home were harassed and jailed. Independent newspapers were threatened. When a cable from the British ambassador describing Mutharika as “autocratic and intolerant of criticism” was leaked, he expelled the British ambassador. Britain responded by freezing aid worth $550 million over four years. When police in mid-2011 killed 20 antigovernment protestors, other aid donors withdrew their support, including most significantly the United States. Mutharika told the donors they could go to hell. To compound matters, tobacco sales, which usually accounted for 60 percent of foreign currency revenues, plunged on diminishing international demand and the decreasing quality of the local product, which had been hurt by a persistive drought.

By late 2011, Malawi was experiencing a full-blown foreign currency crisis. The International Monetary Fund urged Mutharika to devalue the kwacha, Malawi's currency, to spur tobacco and tea exports. The kwacha was pegged to the U.S. dollar at 170 kwacha to the dollar. The IMF wanted Malawi to adopt an exchange rate of 280 kwacha to the dollar, which was closer to the black market exchange rate. Mutharika refused, arguing that this would cause price inflation and hurt Malawi's poor. He also refused to meet with an IMF delegation, saying that the delegates were “too junior.” The IMF put a $79 million loan program it had with Malawi on hold, further exacerbating the foreign currency crisis. Malawi was in a tailspin.

In early April 2012, Mutharika had a massive heart attack. He was rushed to the hospital in the capital Lilongwe, but ironically, the medicines that he needed were out of stock—the hospital lacked the foreign currency to buy them! Mutharika died. Despite considerable opposition from Mutharika supporters who wanted his brother to succeed him, Joyce Banda, the vice president, was sworn in as president. Although no one has stated this publicly, it seems clear that intense diplomatic pressure from the United Kingdom and United States persuaded Mutharika's supporters to relent. Once in power, Banda announced that Malawi would devalue the kwacha by 40 percent. For its part, the IMF unblocked its loan program, while foreign donors, including the UK and United States, stated that they would resume their programs.

Case Discussion Question (Answer must be no less than 250 words)

Why did the IMF recommend that the currency be devalued?

Explanation / Answer

The value of the currencies of small countries is pegged to US dollars. It denotes the amount of the small country's currency that would make one dollar. Rise in the exchange rate or amount of the small country's currency as compared to the US dollar would lead to devaluation of the currency and fall in the exchange rate value will lead to revaluation of the currency. Devaluation of the currency would make it cheaper for foreign residents to purchase goods manufactured in the small country as they will have to give up less dollars to purchase the same amount of the small country's currency. This will boost the country's exports and reduce imports and improve trade balance. In the same way revaluation will increase imports and reduce exports deteriorating the trade balance.

In the case of Malawi, which faced a foreign exchange crisis in late 2011, IMF recommended devaluation of the currency to boost the exports of the country so that the country is able to earn more foreign exchange by making its exports cheaper for the foreign residents and imports costlier for the citizens of Malawi. This will increase exports and reduce imports and thus improve the trade balance of the country. The same policy, among various other measures, was also recommended by IMF in India when the country faced foreign exchange crisis of 1991. This was helpful in increasing exports and also producing import substitutes which helped to increase production and overall income of the home country and also corrected the foreign exchange crisis.

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.