Tanzania shilling was overvalued, says IMF

Friday October 2 2015

The IMF’s Resident Representative in Tanzania,

The IMF’s Resident Representative in Tanzania, Mr Thomas Baunsgaard 

Dar es Salaam. The shilling’s recent plunge was a blessing in disguise because it served to bring the local currency to its genuine value, according to the International Monetary Fund (IMF).

In a report released on Wednesday after an IMF team visited the country, the fund says the shilling was overvalued in 2014, but “is now closer to equilibrium” at the current rate of Sh2,100 to the dollar.

The local currency crashed to an all-time low exchange rate of Sh2,300 to the dollar in June, but “a combination of measures, including a tightening of monetary policy and seasonally higher export earnings, subsequently helped to stabilise the shilling and allowed a return to normality in the interbank and foreign exchange markets since August 2015,” the IMF further notes in its report.

The IMF’s Resident Representative in Tanzania, Mr Thomas Baunsgaard, told The Citizen yesterday that because inflation in Tanzania had been higher than in most of its trading partners, the fund was of the view that the shilling was overvalued in 2014.

“The depreciation experienced in the first half of 2015, mainly in response to the strengthening of the US dollar, has had the positive effect of moving the shilling closer to its equilibrium,” Mr Baunsgaard said, echoing the report’s findings.

The Bank of Tanzania (BoT) confirmed to The Citizen that it also carried out an assessment last year that showed that the shilling was overvalued by 17 per cent. The shilling was at that time ranging between Sh1,600 and Sh1,700 to the dollar. Another assessment conducted recently when the shilling was pegged at Sh2,100 to the dollar established that the currency was overvalued by two to three per cent. The BoT Director of Economic and Policy Research, Dr Joseph Massawe, said this was an acceptable range.

Effects of an overvalued shilling

An overvalued currency has a negative impact on the economy. “An overvalued exchange rate makes exports less competitive. It also makes it more difficult for businesses producing goods for domestic consumption to compete with imports,” Mr Baunsgaard told The Citizen by email.

He added that a currency that was well-aligned with the economic fundamentals helped farmers and businesses to expand their production.

There was mixed reaction by economic experts on whether the local currency was indeed overvalued. Prof Delphin Rwegasira of the University of Dar es Salaam said the overvaluation was understandable because Tanzania was dependent on imports and the huge import bill put pressure on the exchange rate.

“Even if the exchange rate policy is determined by market forces, the Bank of Tanzania is obliged to intervene from time to time, to buy or sell dollars from its reserves, to ensure that the shilling does not fall too much as this can have a negative impact on inflation. It is here that the intervention could lead to overvaluation,” he said.

Prof Honest Ngowi of Mzumbe University disputed the assessment showing that the shilling was at one time overvalued.

It required a drastic action by the central bank for a currency to become overvalued, he said, noting that this had not been the case in Tanzania.

“I met the IMF team and I told them that I did not believe that the shilling was overvalued because market forces were at play without too much interference by the central bank,” Prof Ngowi said. He added that BoT did not intervene aggressively when the shilling plumbed new depths earlier this year and there was no reason to believe that the central bank took action that could have led to overvaluation in 2014.

“There was talk of BoT borrowing from South Africa and some other countries, but it did not do so even as the exchange rate was highly volatile,” Prof Ngowi noted.

The policy in Tanzania is to let market forces determine the level of the exchange rate in line with economic fundamentals. However, Mr Baunsgaard said the adjustment is not always smooth and could cause the exchange rate to overshoot.