Note from the ZNCC Exchange rate mispricing and threatening inflation
IN the 2017 Mid-term Monetary Policy Statement, the Reserve Bank of Zimbabwe (RBZ) clearly and unequivocally spelt out the indispensable pre-conditions for the return of the local currency as follows: sustainable foreign exchange reserves (equivalent to one year import cover); sustainable Government budget, demonstrable consumer and business confidence, health of the job market, and average industrial capacity utilisation of above 75 percent.
However, in trying to reconcile the above with the status quo, the following revelations should be interrogated:
◆ Foreign currency reserves — total official reserves (including gold) were estimated to be around US$590 million in 2022. This can only cover about one month of imports. To put this into perspective, Zimbabwe’s imports for the month of January 2023 totalled US$635 million, and imports for the first quarter of the year alone totalled US$2 billion. Given the high demand for USD, the country had a US$970 million gap in foreign currency supply despite receiving record breaking forex receipts in 2022. ◆ Sustainable Government budget — the ZWL$4,5 trillion 2023 National Budget that was set in November 2022 has been eroded by inflation and exchange rate movement. Using the official exchange rate, the budget was valued at about US$6,88 billion when it was announced on 24 November and is now valued at US$3,71 billion. And when we use the current parallel market exchange rate, the budget is only worth a paltry US$1,73 billion. This is not sustainable and calls for another huge supplementary budget, if government is to meet all its expenditure targets for the year. ◆ Demonstrable consumer & business confidence — business confidence is generally low in the market. During the period between May and September 2022, ZNCC through the State of Industry and Commerce Survey reported that business confidence was in the negative signifying pessimism and this could have been worsened by the current economic trajectory.
◆ Health job market — with over 65 percent of the economy being informal, many people are still unemployed and underemployed, and many do not have decent jobs, which is a constitutional right as per the dictates of Section 24 (1) of the country’s constitution. Levels of productivity in industrial sectors have declined especially for ZWL$ earners as the real wage has fallen drastically.
◆ Average industrial capacity utilisation of above 75 percent — industrial capacity utilisation is still constrained in some sectors of the economy which are still recovering from Covid-19 losses. Companies are still operating with antiquated machinery which makes them uncompetitive, are also experiencing intensive electricity shortages, with some sectors now having to face stiff competition from imports, following the removal of import restrictions on basic commodities. In 2022, industrial capacity utilisation for the manufacturing and construction sectors stood at 60 percent (ZNCC State of Industry Survey), which is still low when compared to the 75 percent target. Against this background, it is clear that none of the above preconditions for the return of the local currency were met, which to some extent explains the current challenges being experienced regarding exchange rate depreciation. In the shortto-medium term, these pre-conditions will also not be attained.
The implication has been the gradual move towards full dollarisation, with over 76 percent of transactions now taking place in US dollars.
The acceptability of the Zimbabwean dollar as a medium of exchange is dwindling by the day and the local currency is also continuously losing some of its fundamental qualities of good money.
The exchange rate has depreciated by 616,93 percent over the period between February 2022 and February 2023 on the official market. Between January and April 2023, the exchange rate has depreciated by about 37 percent.
This indicates high instability in the exchange rate.
The local currency component of broad money supply increased by 318.67 percent, while the foreign currency component increased by 677,10 percent.
The increase in foreign currency deposits is largely attributable to the exchange rate movement which is also a contributing factor to the rising prices of goods and services, particularly in local currency, as businesses seek to compensate for the loss of value.
Holding huge local currency balances for more than a week is more likely to result in exchange losses. It is convenient to hoard goods or pay forward for goods and services than to hold on to the Zimbabwean dollar.
Thus, the velocity of circulation of the local currency is quite significantly high as corporates and individuals seek to quickly dispose-off the Zimbabwean dollar as soon as they receive it. The current exchange rate management system in Zimbabwe is inefficient.
The recent movement in the exchange rate is caused by a diminished appetite for the local currency (ZWL).
Given the amount being allotted on a weekly basis has been averaging about US$19.4 million between 14 March and 09 May 2023, the relevance of the RBZ weekly auction system is now in question given the operation of the Willing Buyer Willing Seller (interbank) market.
In the instance, the Government has indicated desire to eliminate harmful and destabilising arbitrage conditions that have pervaded the economy at the expense of the generality of the citizens.
With gold coins (physical and digital) and an inefficient foreign exchange market (the co-existence of the auction system and the interbank market), eliminating arbitrage conditions may be difficult to achieve in the short-to-medium term.
Banks should be allowed to fully participate and take lead in the foreign exchange market. It is unfair to allow a proportion of the market that accounts for 30 percent of the import bill to determine the exchange rate.
However, in the short term, the Bank should continue restricting the access to the auction system to critical sectors only on a pure Dutch auction basis.
After reaching levels of around 25 percent in the third quarter of 2022, the parallel market premium has reached the 2021 third quarter levels.
The official US$1/ZW$ reached the ZWL$1000 per dollar mark in the third week of April 2023.
The trend in the blended m-o-m inflation rate has not been in tandem with the trajectory in the official exchange rate suggesting a lack of an economically significant relationship. The blended m-o-m inflation rate has been trending downwards since reaching a two-year high of 18 percent in June 2022.
However, following the recent pricing developments in the economy, the m-o-m blended inflation rate started to peak upwards between January and April 2023. The year-on-year rate is on a downward trajectory which may not be sustained into the second half on account of the looming 2023 general elections.
Following the recent developments in the economy, the Government is urged to prioritise macroeconomic stability as a key pillar for the success of the National Development Strategy I.
Curtailing excessive expenditure and keeping money supply growth in check will go a long way in restoring exchange rate and price stability.
The demand and usage of the Zimbabwean dollar is critically minimal since foreign currency is needed even when paying for government services.
Thus, promoting the use of local currency by allowing taxes, duties and levies to be paid for entirely in local currency is expected to increase its demand and usage. Without external budget support, there is a need to relook at the financing models for government programs away from the usual (tax revenues and seigniorage).
Strengthening the local currency bond market would help finance budget or revenue deficits in a non-inflationary way.
In conclusion, the exchange rate remains the elephant in the room and finding a stable exchange rate path is a crucial step in restoring price and macroeconomic stability.
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