Inefficient foreign exchange market costing Zim billions
SINCE the relaunch of the interbank market in February 2019, Zimbabwe has experienced challenges in attracting foreign currency to the financial sector.
This has created a sustained foreign currency shortage in the economy where producers have to rely on the parallel market for liquidity to import essential raw materials and pay for external obligations.
In 2019, only US$1,5 billion was traded on the interbank market versus local demand that exceeded US$7 billion. Currently, there is not much activity on the interbank market as supply has dwindled.
This is despite the fact that in 2019 the country exported goods worth US$4,2 billion (average of US$350 million monthly), received remittances worth more than US$1,2 billion (diaspora remittances of US$635 million plus international remittances of US$521 million) and foreign direct investments totalling US$259 million.
The portion of diaspora remittances is 50% of the possible figure as most remittances are now being channeled via informal channels such as cross-border traders, buses and truckers. The major reasons why Zimbabwe suffers from foreign currency shortages can be traced back to a lack of confidence (trust) in financial institutions, especially the country’s apex bank, repressive exchange control regulations and an inefficient foreign exchange market that does not give fair value to buyers and sellers.
After months of covert massaging of the interbank rate, the Reserve Bank of Zimbabwe (RBZ) suspended the newly instituted managed float exchange rate and fixed the exchange rate at US$1:ZW$25 on March 26, 2020. Treasury had announced the introduction of a managed floating exchange rate two weeks earlier so as to bring the urgently needed efficiency and transparency to the interbank market.
The short-lived managed float platform was managed by the Reuters System which had been on trial since December 2019. The Monetary Policy Committee (MPC) has indicated that the interbank rate will be liberalised on a date which is yet to be communicated.
The central bank has justified fixing the exchange rate on the basis that it provides stability and certainty in the market. However, instability is unfolding as the local currency plummets thus pushing inflation to record levels only witnessed in 2008. Nonetheless, dictating and fixing the exchange rate allows the central bank to expropriate exporters’ earnings at very low prices through crediting their accounts with electronic money.
Floating the exchange rate would mean that the central bank pays exporters a market-determined rate to seize a portion of their export receipts, which ultimately fuels inflation, provided the bank maintains its export retention regime.
Among other uses, the central bank is using export earnings to settle debts owed to Afreximbank and other foreign lenders. The central bank estimates more than US$2 billion is circulating in the informal market while foreign currency accounts (FCA) holders are holding on to more than US$1 billion for their operational needs.
Foreign currency has turned into a commodity of choice due to the depreciation of the local currency and inflation, which is set to eclipse 860% for May 2020. Demand for foreign currency has never been as high with US$1 fetching almost ZW$90 on the parallel market this week. Pressure on foreign currency is expected to be sustained as the economy re-dollarises and market players rush for cover in the US dollar to preserve value.
An efficient foreign exchange market is key to enabling the transfer function in international trade, provision of short-term credit to importers and for hedging against exchange rate risk. Zimbabwe’s foreign currency receipts rank higher (or are very comparable per capita) to those of other sub-Saharan countries such as Malawi, Rwanda, Tanzania, Kenya, Botswana, Namibia and Zambia.
However, these countries do not experience acute foreign currency shortages because they have efficient foreign exchange markets that provide liquidity in the economy and afford their local currencies some form of stability. Their inflation levels are also not a cause for concern to economic agents.
Remittances leaking
Zimbabweans in the diaspora send home more than US$1 billion per year (formally and informally) to their families. If the foreign exchange market were efficient and there was confidence, diasporans would use formal channels to send money back home while recipients would simply exchange the foreign currency for Zimbabwean dollars through the same banking channels.
However, international money transfer companies have to work round the clock to import US dollars for cash withdrawals. Once withdrawn, the foreign currency finds its way to the thriving and open parallel market where there are no controls.
Externalisation headache
Each year, Zimbabwe loses millions of dollars in foreign currency through externalisation and illicit financial flows (IFIs). The Zimbabwe Anti-Corruption Commission (Zacc) recently pointed out that it had identified cash and property totalling US$7 billion stashed abroad by local companies, politicians and other influential persons.
Some of these assets are proceeds of crime and corruption. An efficient foreign exchange market would provide a medium of transferring capital formally and would allow businesses to hedge against risk without concealing their dealings from the authorities. For their part, exporters have taken advantage of financial loopholes to keep their export earnings in foreign offshore accounts since the foreign exchange market back home does not provide value for their retained export receipts.
Exporters have also expressed frustration at the difficulties they face in getting foreign currency when they need it and the impending trust issues with regards to what the central bank might do to FCA balances locally.
In May 2019, Treasury highlighted that exporters were holding on to US$1 billion in their offshore accounts. Much of these funds are benefitting efficient financial markets such as South Africa, Zambia and Botswana where exporters have nostro accounts.
Shortage to industries
The foreign currency shortages are hitting local manufacturers hard with industrial bodies branding the interbank market as non-existent. Manufacturers require an average of US$300 million per month to import raw materials and settle foreign debts.
However, foreign exchange inefficiencies mean that the cost of production is constantly going up and final prices reflect parallel market premiums which are unsustainable.
In 2019, Zimbabwe’s imports fell from US$6,4 billion to US$4,8 billion as a result of foreign currency bottlenecks. This might look positive at face value; however, declining imports that are not matched by import substitution mean that production is shrinking as less value-adding commodities are imported and manufacturers scale back on production.
An inefficient foreign exchange market is costing Zimbabwe billions of dollars that would ordinarily be channeled via the formal financial sector by various economic players such as remittance receivers (households), labour, exporters, non-governmental organisations and multinational corporations.
It also means producers who import raw materials and pay for various business services abroad have limited access to foreign currency at competitive rates for production purposes. Local retailers in the formal and informal markets who trade in foreign currency also avoid the interbank market and trade in hard currency, thereby circumventing various taxes or levies.
The central bank has allowed customers to pay using foreign currency for various goods and services. However, most businesses are not banking the foreign currency proceeds and are evading various taxes such as Value-Added Tax in the process. Perpetuating an inefficient foreign exchange market ultimately serves no one’s interest as the economy will continue declining while billions circulate in the informal economy or leak through externalisation.
The central bank has to revert back to an electronic foreign exchange system that provides transparency and reflects open market forces. Inevitably, prices of basic goods and services will skyrocket in the short term. However, they will eventually stabilise once the exchange market reaches an equilibrium point and confidence is restored in a market where commercial banks play their role as market makers (not the central bank).
An efficient interbank market would provide a distant fighting chance for the Zimbabwean dollar to survive. As it stands, it all points to rapid re-dollarisation of the economy and price hikes despite the best efforts of the central bank to contain inflation. An inefficient foreign exchange market cannot work in a market where the central bank seizes exporters’ earnings, let alone using a fixed interbank rate.