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Modelling currency in circulation in Malawi

Listed author(s):
  • kisu simwaka

    (Reserve Bank of Malawi)

The purpose of this study is therefore twofold. First, to establish the claim that currency in circulation has been rising. Second, to empirically quantify and give a full account of the reasons determining the dynamics and volatility of currency in circulation. Using annual data for the 1965-2004 period, this paper confirms that currency in circulation as a proportion of money stock has increased. From the initial estimation results, the paper establishes strong positive effects of inflation rate, underground economy activities, financial deepening on the CU/M2 ratio, and significant negative effect of interest rates on this ratio. The other highlight result from this study is the positive and significant association between small-scale agriculture produce and CU/M2 ratio. Using annual data, among other things, this study confirms findings from other studies that cash preference is a function of real interest rates. However, one striking finding here is the importance small-scale agriculture as a determinant of currency in circulation. This reflects the agriculture-dependent nature of the economy. Better performance of this sector injects cash in the economy and because of the lack of banking facilities in rural areas, most of the injected cash remains in circulation. The message from empirical results using monthly data is similar, with interest rates, financial deepening, tobacco selling season dummy and inflation rate playing significant roles in determining movements in currency in circulation. As expected, technological innovations in the banking system or payment systems, particularly cash dispensers (ATMs) have a significant impact on the overall level of currency in circulation, whereas no major impact seems to come from the MALSWITCH smart card, however, initial indications reveal its negative effect on the CU/M2 ratio. Policy implications from these results are many. First, of late the Bank has reduced the bank rate and as is normally the case, all other interest rates were similarly adjusted. While the policy move has or is on course to achieve its intended goals, it has other side repercussions such as deposit taking capabilities by commercial banks. Currently, the minimum saving rate for the four major commercial banks averages around 7.5%. This against the current monthly inflation rate of 12.2 (for October 2004) leaves real savings rate of around –4.7% which rationally discourages savings mobilisation and consequent reduction in the availability of loanable funds for productive investment and economic growth. The public is most likely to hold their assets in cash rather than bank deposit form since the opportunity cost of doing so is essentially zero. However, due to high inflation in the past, savers in Malawi were used to high interest rates so that current demand deposits are considered as unattractive and non-worthwhile form of holding money. It is time the public get used to lower interest rates as in other countries and on the belief that causality direction is from interest rates to inflation, the reduction in the bank rate could eventually lead to a drop in inflation and, therefore, an increase in the real interest rate. Second, if the Bank intends to focus on reducing the CU/M2 ratio, intensification of smart card use and publicity could play an important role. The smart card is a direct alternative of cash as a means of payment so that its widespread use can directly reduce currency in circulation. This, as is the case in other countries could also reduce the positive impact of ATM transactions on the overall level of currency in circulation. Third, the overall civic education on the use of banking facilities, in rural areas as well as to small-scale business men (vendors) is important for increased deposit taking and, therefore, the reduction in the amount of currency in circulation.

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Paper provided by EconWPA in its series Macroeconomics with number 0504018.

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Length: 18 pages
Date of creation: 13 Apr 2005
Handle: RePEc:wpa:wuwpma:0504018
Note: Type of Document - txt; pages: 18
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