Forex auction system outperforms expectations

FOLLOWING introduction of the foreign exchange trading system on June 23, 2020, the market sentiment was mixed. We predicted that the authorities had adopted the correct approach and that this system would bring order into the market. We argued that stability would result from the predictability of the local currency exchange rate.

There is an apparent new variable on the Zimbabwean economic scene which is negative expectations.

While the introduction of the auction system was the correct route, it was met with negative expectations that resulted in a discernable resistance bordering on cynicism even from some large corporate organisations.

The system was launched amid doubts from some players with some showing clear signs of resistance to the system and kept on pricing goods at the parallel rate. This has been most prevalent in the retail sector.

It was argued that the system would prove unsustainable and these sentiments arose from the country’s previous experiences during the era before dollarisation in 2004. However, to date, the new system has performed superbly and it is important for the market to accept the reality that other economists had anticipated.

The authorities must be applauded for constantly improving the quality of information released after each auction.

At the start, some important data such as the number of applications received, the number of applications rejected, and the reasons for such rejections was not published.

As the system developed, such information is being added onto the weekly bulletins. This is a commendable move as it eliminates doubts through making the system very transparent.

As per expectations, while the highest bid prices were very high close to the parallel rate of 105 at the first auction, that rate has gradually fallen over the subsequent four auctions and by July 14, the highest bid rate converged with the parallel market and continued into the 5th auction as at July 21, 2020.

It means the highest bids are now at the same level as the parallel market rates, which itself was coming down.

On the bottom end, the lowest bid rate moved from the official pegged rate of 25 at the beginning and nudged up following the weighted average auction rate.

A convergence is apparent as illustrated by the narrowing gap in the table below which should be exciting news for both the market and the authorities.

The market is responding well. Socially we expect this benefit to start filtering through by way of stable consumer prices. The dream for low inflation is not too far-fetched after all, provided the authorities maintain steady the current tight conditions on both the monetary and fiscal policies.

As evidence of this tight control regime, the recently announced budget review did not carry any supplementary requests. The month of July has so far experienced price stability with no major movements especially on the retail shop floors which are directly experienced by consumers.

What is intriguing is the sharp fall in the differential between the top bid prices and the bottom over the 5 auctions.

This differential began at 75 on the first auction of June 23, and has consistently declined to 12 at the fifth auction on July 21, 2020.

The important highlight in this regard is that the auction system is a price discovery mechanism and the market is allowed to freely determine the rate.

The convergence of these two rates, as independently determined by the players, is a strong positive.

Further, at the fifth auction, as a sign of increased confidence by the market, exporters supplied close to US$2,5 million onto the market. This is a sign of exporters beginning to supply the foreign currency which helps to strengthen the system and enhance its sustainability going forward.

The authorities are encouraged to maintain strong supportive actions.

The auction has mopped up about $3,6 billion liquidity from the market and when this is considered in conjunction with current reserve money that has declined to below $10 billion, together with the fact that the country’s expected foreign currency earnings from exports are above US$6 billion, our projection is that these rates should converge and tapper off around the 75’s range before possibly falling to the 60’s range as a unified rate.

Odds are now in favour of the Zimbabwe dollar. However, this can once more be wiped off if the authorities lose sight of money supply controls.

For now it is thumps up for the authorities. It has been good work so far.

◆ Misheck is a former expatriate banker based in several SADC countries and currently works as a Corporate Advisory Services Consultant. He is the founder of Rucabel Investments Private Limited, an investment company based in Zimbabwe. He is a member and past Vice President of the Zimbabwe Economics Society.