By Donasius Pathera, PhD:
In sub-Saharan Africa, central banks are focusing on price stability as the main aim of monetary policy, but their efforts are not consistent.
Many still pursue other goals such as economic growth, financial development and foreign market competitiveness.
This unclear policy focus leads to erratic monetary policies, with conditions sometimes relaxed to meet certain goals, then tightened later due to inflation worries.
One big issue is the important role of managing exchange rates in policy strategies, even in places with some exchange rate flexibility.
In some countries, exchange rate stability is seen as more important than price stability, which can cause misalignments and hurt the credibility and effectiveness of monetary policy.
This problem is worsened by the absence of a clear medium-term inflation target in many countries, which hampers policy discipline and makes it easier for political influences to dictate decisions.
Additionally, many do not have a solid plan to manage competing goals without harming price stability.
The operational approach in the region still largely relies on reserve money targeting (RMT), a method taken from International Monetary Fund programmes focusing on central bank balance sheet targets.
Some central banks are using policy interest rates to show their policy direction, but this is inconsistent, leading to frequent differences between targets and actual outcomes.
Consequently, the direction of monetary policy often lacks clarity and policy transmission becomes ineffective, especially with repeated interventions in foreign exchange markets.
A key problem in monetary policy systems in the region is the lack of a forward-looking plan and clear communication for policy decisions.
This gap reduces the capability to deal with inflation changes and react to outside influences, like rises in commodity prices.
When there is a mismatch between policy goals and what is actually done, it often causes confusion and weak policy actions.
Despite these issues, efforts are ongoing to modernise monetary policies in the region.
A main takeaway is the need for central banks to have operational independence and clear goals for price stability.
Central banks can advance in different areas and, at the same time, reform needs to be thorough, combining strategy, operation and communication. Managing exchange rates is still a vital concern for many nations, especially those with flexible exchange rates.
Central banks in these countries have to manage complex monetary policies that balance local stability with international financial conditions. As these nations improve their monetary systems, the significance of exchange rates has increased, with a stronger focus on price stability in monetary policy. Even with this change, managing exchange rates is crucial for lessening economic swings and outside shocks.
Countries have made significant strides in moving towards more flexible exchange rates, with a growing recognition that the exchange rate should not serve solely as a nominal anchor.
Instead, central banks focus on price stability, albeit with active foreign exchange interventions aimed at stabilising the real exchange rate in response to market fluctuations.
These interventions, while not eliminating exchange rate management, represent a shift from targeting specific exchange rate levels to smoothing out rapid fluctuations that could derail inflation control efforts.
The concept of sterilised interventions—where central banks intervene in FX markets while maintaining control over short-term interest rates—has been instrumental in many emerging market economies with inflation targeting regimes.
This allows central banks to influence exchange rates without compromising their primary inflation goals.
In SSA, the challenge lies in ensuring that these interventions do not undermine the credibility of the monetary policy regime or distort the natural shock-absorbing role of exchange rates.
Central banks face the delicate task of determining when to intervene in currency markets. While frequent interventions can provide short-term relief, they can also create uncertainty and reduce the clarity of the policy framework.
The key question is whether central banks can identify when exchange rates are misaligned with their long-term equilibrium, and whether interventions will provide lasting benefits.
Over-intervening may inadvertently weaken the ability of the exchange rate to adjust to external shocks, a risk that central banks must carefully weigh.
In the case of countries in the CFA franc zone, which peg their currency to the euro, and other African nations with hard pegs to the South African rand, exchange rate stability offers the advantage of low inflation.
However, these countries also face significant constraints on their monetary policy. Hard pegs limit the ability of central banks to adjust interest rates or inflation targets in response to local economic conditions.
The CFA zone, in particular, has experienced challenges related to the need for real exchange rate adjustments, which often come with painful inflationary consequences.
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