Inflation needs conventional fixing

THE Monetary Policy Statement this week has bad news and good news, the bad news centring on the way the black-market for foreign currency continues to mess up the economy while the good news centres on the determination to “stay the course” and continue pushing measures that get around those effects.

From the launch of the Reserve Bank of Zimbabwe auctions at the end of June in 2020, and especially since September 2020 when that new system reached stability, monthly inflation was plummeting and by the middle of last year the target of 2 percent a month was achievable. Then monthly inflation started rising, quickly going above 5 percent, largely driven by the black-market exchange rate.

Some of this could have been expected. The auction system, while working, had developed long delays between allotment of currency and the actual transfer of that currency. Some businesses managed and some had to resort to the black market to fill the gaps, and so price accordingly when they fed the exchange rate into their pricing formulas.

Some was the result of people who were not facing that fact deciding to use the black market rate to price, even when they were using local currency and auction foreign money, or only using a small percentage of black-market currency. Once again we had a strong drift to US dollar secret accounting, different from the accounts given to Zimra which reflect actual currency, and then conversion at what someone reckoned could be the black market rate next month.

Not all businesses did this, at least outside the luxury trade and the medical sector, where no one even pretends to use actual costs or auction rates, but still enough to cause problems.

So annual inflation beaten down to just over 50 percent by June went up to just over 60 percent by year end, not a dramatic jump but still a reversal of the steady progress and stopping the expected steady progress down to something below 30 percent by year end and continuing this year to perhaps single digits by year end.

To a degree part of this was the inability to feed the auction system with enough to meet instant demand, and that in turn appeared to be a result of both the very temporary negative current account early in the year, although this improved dramatically, and the determination by net exporters to keep every dollar they could manage in their FCA, spending as little as possible and certainly selling nothing. And the banking sector has still not been able to tap the growing pile of cash in FCA deposits; it just sits there.

The auction system has now been fixed, and is being run realistically. The Reserve Bank appears to now be treating the auctions as inflation neutral since the major reforms in all sort of monetary areas from October last year and is using its one practical action to set the base allotment rate. We saw that again this week when all bids below just under last week’s average were rejected, although from the total of the valid bids not allotted there were not many major bids in that range, a change from last week. But 116 valid bidders missed out with the SME sector now discovering they have to conform to the drift.

But with just over 2 percent drift in exchange rates, and the sudden narrowing of allotment bands, it appears that a lot of bidders just added a small extra and finance managers are getting better at not overbidding. So we have moved to a far better level of stability in bidding, with the rate drifting but people able to predict this a lot better and so pitching bids that can be allotted into narrower ranges.

While tightening up on the bid procedures to remove cheating and speculation from the auctions, since cutting back on essential imports, the other alternative control, is not really practical, the Reserve Bank seems to be switching from trying to control the uncontrollable black market to going for more control of money supply and liquidity to dry up speculation.

This is the classic and conservative approach to fighting inflation. Here there is need for fine calculations. Anyone can dry up cash, but the need is to reduce growth in money supply without totalling the economy, and in the Zimbabwean case to maintain economic growth and development, which also sees a rising Government budget for infrastructure maintenance and development.

RBZ governor John Mangudya acknowledged that this was only possible because the Government is maintaining its strict fiscal discipline, so although there are surges in spending, such as when the farmers need their inputs and need to sell their crops, this is covered by the build up and draw down in what is in the Government accounts. Having the Government being what in effect is easily the largest merchant bank is a curious by-product of our economic growth, but not one that can be suddenly changed. And the debt hangover from the indiscipline days is still a factor, although being managed.

So money supply continues to be at the top of the RBZ’s ordinary agenda. Very strict control of the reserve money, and ever tighter targeting of the levels here, is still a top priority. So we saw interest rates rise and nothing coming down in the latest statement, but interestingly consumption borrowing rates are now round about inflation rates, so at least we are not subsidising that.

In fact, when you throw in the fact that a lot of consumption is using black market currency, or is priced into the black market rates, borrowing for consumption, and especially borrowing to play the black market, are no longer realistic options. You have to have cash, and that helps explain the incredible gaps between buy and sell rates in the black market.

From the end of last year the Reserve Bank and the Monetary Policy Committee have also been paying a lot more attention to broad money. Here it is not so much targeting but seeing where the growth comes from and seeing how the narrower measures can effect this.

M3 growth is still high, but it had plummeted to just over 100 percent by year end. There are a number of contributors to M3 but most do not matter much, like cash in circulation is 0,4 percent. The two that do matter are the transferable deposits in local currency and the FCA accounts. The action on reserve money obviously does a lot to control the local deposits driving money supply growth and the Reserve Bank is using its auction rules and interest rates to control that further.

The FCA contribution automatically rises every week when the new auction rate appears and causes a revaluation of what is in those accounts, along with the growth of the actual foreign currency being stuffed in them, almost US$2 billion. But as a lot of that money is not being used the actual M3 in play is not rising anything close to 100 percent a year, but still it is a nuisance.

The central determination of the Reserve Bank to go after the fundamentals, rather than the peripherals like the black-market, is the right approach. The black market is a result of some very bad history and we have to continue to “stay the course” on fixing that, and then the peripherals will sort themselves out.

The rise in foreign currency inflows to US$9,7 billion last year is one of the major fixes of the underlying fundamentals. Even when we exclude the IMF transfer, the inflows still broke the old record significantly, showing that the push for proper economic growth is the only way to go and that growth will, in the end, mean that the black market will sink to the sort of level that we can expect and basically ignore.

In the meantime we continue with the progress.