THE EFFECTS OF DEVALUATION

In 1983 the IMF were understood to be pressing the Tanzanian Government to devalue the shilling from Shs. 12.6 to the American dollar to between shs. 25 and shs.35. In free market conditions, where the money earned by exports and services falls short of the money spent on imports and other external obligations, the value of the local currency will tend to fall in relation to foreign currencies. The effect of such currency depreciation will be to make imports more expensive in local currency terms and exports cheaper in foreign currency. As a result, imports will fall and exports will be encouraged to expand until a new equilibrium is reached. That is the simple theory.

But this simple theory has little meaning in a very poor primary commodity exporting country already restricting imports to a few basic necessities. In such circumstances the consequences of devaluation are complex and are most unlikely to follow the predictions of the simple model. While serious disequilibrium is easily recognised, an ideal or equilibrium rate of exchange is hard to establish. This has been seen recently in the discussions surrounding the sterling rate of exchange, where the interests of exporters, of importers and of the government have seemed to conflict.

First, there may be no scope left for choking off demand for imports, so that the import bill is not reduced. Secondly, the external prices of export crops are determined in world markets and the effect of devaluation here is limited to the indirect one of yielding higher domestic currency returns for given world prices. Thirdly, the stimulus to exports is not an instant reaction to higher prices. While there is ample evidence in Tanzania that farmers respond sensitively to changes in profitability, any marked increase in output will require new planting which, in the case of most export crops, will come into production only after a gap of several years. Further, the government has to consider the impact of export stimulation on food crops. Devaluation does nothing to enhance the profitability of food crops and may even reduce it by increasing the cost of transport and of imported fertiliser and insecticides. Any increased return to food crop producers, therefore, has to come from the consumer, or from government subsidies, or from savings on the handling and marketing of crops. It would, however, make no sense if food crop production were to suffer from a transfer of attention to export crops, resulting in the need for higher food imports. On the contrary, greater food production is one important way of correcting the imbalance in the foreign exchanges.

It seems likely the IMF’s advocacy of drastic devaluation has rested in part on the assumption that a substantial proportion of export crop production is disposed of in the more lucrative black market and is therefore lost to the nation’s foreign exchange account. A rise in official producer prices would therefore, it is assumed, restore the black marketed output to official trading channels, where it would substantially add to official foreign exchange earnings. The IMF may well over-estimate black market losses, for which there seems to be little evidence in the figures for the amounts officially marketed. It is possible, therefore, that the IMF in their calculations have set the corrective action too high and it remains to be seen whether the devaluation recently announced will be sufficient to eliminate such black market wastage in the form of unofficial cross-border sales to neighbouring countries.

Devaluation has the advantage of increasing producer incomes at no expense to the government by increasing the local currency income from sales. Some of the increase will be absorbed by greater production costs, which rely heavily on imports, notably transport, but a margin for increased profits should remain. The IMF clearly places reliance on the profit motive to induce farmers to produce more for export, but the reaction of farmers to monetary incentives is likely to be coloured by the availability on the shops of desired items of common consumption. Since the shops are largely bare of such items, the impact of devaluation will depend in part on the rehabilitation of consumer goods industries. Unfortunately, devaluation increases industrial costs and does nothing to encourage industrial growth for the home market.

The rise in the cost of imports in local currency terms will inevitably raise the cost of living. The extent of the rise will depend both on the import content of common consumer goods and also on the increased production costs of local commodities, notably food. The higher cost of fuel, machinery and vehicles for cultivation and transport will be an element in higher food costs. There has been disagreement between the government and the IMF about the inflationary consequences of their proposals for devaluation, but that there will be a substantially increased burden on the consumer, particularly in the urban areas, there can be no doubt. In view of the already intense pressures on the urban poor, the government has to take this effect carefully into account in their calculations as to the extent of devaluation that can be accepted.

This summary of some of the effects of devaluation, though incomplete, is sufficient to show that the timing and extent of devaluation are not matters for nice monetary calculation, but involve political judgments and the offsetting of benefits against costs, which in the last resort only the government can do. Any devaluation policy entails real losses in consumption and investment. The problem for government is to minimise these losses and to distribute their impact in such a way as to safeguard the urban poor, while securing the maximum adjustment in the balance of payments. It is worth keeping in mind that for Tanzania export rehabilitation is the only permanent and sound means of restoring balance to the foreign exchanges. Consequently, the government has to keep an eye fixed on the impact that any package of measures may have on the exporters. This is not Simply a matter of producer incentives, but involves action on a wide front to produce and distribute the inputs necessary for export production to create, in effect, an environment conducive to export growth.

The recent package of measures described elsewhere in this issue involving a devaluation of 26% is the outcome of the government’s detailed scrutiny of the problem in all its aspects. It is to be hoped that it will be sufficient to attract the sympathetic cooperation of the IMF.

J. Roger Carter

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