Exchange and Interest Rates Determination

Exchange and Interest Rate Determination in Malawi: Past and Present

1.0 Introduction 1.1 Since independence, Malawi has adopted various policies to ensure, among other things price stability, a sustainable external position and faster economic growth and development. To achieve this, Malawi has used various policy instruments which have included exchange rate and interest rate adjustments. The choice of an exchange rate policy in any country has an important role to play in creating the proper environment for economic growth. The exchange rate policy chosen affects the country's relative price structure between tradable and non-tradable goods and ultimately the overall level of domestic prices. Thus, a particular exchange rate system chosen does have far-reaching effects on the entire economy. 1.2 The management of the exchange rate in Malawi can be traced from the year the country got its independence. At that time, the country's currency was fixed at par to the British pound sterling. From that period onwards, the determination of the country's exchange rate has evolved over time, having been pegged to the weighted average of the pound sterling and the US dollar; to the IMF's Special Drawing Rights (SDR); to the weighted basket of seven currencies; and, recently the currency has been allowed to move according to the forces of demand and supply. 1.3 Regarding interest rates, until the late 1970’s Malawi experienced a high degree of financial repression, with administered interest rates, credit ceilings, segmented capital markets and excessive intermediation costs. As part of structural adjustment programs supported by the World Bank and the IMF, Malawi has been implementing structural reforms in the financial system for close to two decades now. The main objective of these reforms has been more efficient mobilization of resources and optimal resource allocation. One of the most important aspects of financial reforms was interest rate liberalization. 1.4 The paper...