Floating exchange rate will take us to 2008
IN RECENT weeks there have been tremendous calls on the need to float the exchange rate as the existing 1:1 rate between the real time gross settlement (RTGS) and the United States Dollars is seen as undesirable. The intention of this article is not to be a monopoly of wisdom on the subject but rather aims to help readers in a logical way appreciate the possible consequences coming out of floating the rate.
Is the 1:1 rate realistic?
Basic economic fundamentals obtaining on the ground characterised by serious disparities between RTGS balances and hard notes and coins available clearly shows the rate of 1:1 rate is not realistic. The laws of demand and supply if fully applied through floating will result in an exchange rate that is very steep, that is, exceeding the current parallel market rates.
Why is the Governor of Central Bank insisting on 1:1?
The rationale of the Reserve Bank of Zimbabwe Governor in maintaining the rate of 1:1 is coming on the back of the undesirability of floating the rate. For the layman, the following are two obvious consequences of floating the exchange rate:
(1) Flouting Finance Act, the Finance Act of 2009 which saw the introduction of the multiple currency regime pegged the rate at 1:1 which formed the basis of all trade deals which the country and business entered into. Abandoning the 1:1 will be illegal as it violates the Finance Act and obviously raise the risk premium on investments.
(2) Overshooting of exchange rate, the proponents of a free float are obviously assuming that the country has enough foreign exchange to back the float. In the absence of adequate foreign exchange in both informal and formal market, the rate will shoot sharply to astronomical rates which can go as far as above 1000%. This will result in immediate loss of savings and pensions as well as the total collapse of the economy. The collapse of the economy will be facilitated by the vicious cycle coming from the need to raise salaries by the same rates, increase in the cost of utilities by the same rate, increase in the cost of raw materials and associated cost of doing business by the same rate at a time where the cashflows both companies and government will be lagging behind. This will take us into 2008 overnight. In as much as the 1:1 comes with exchange rate losses, it still makes logical sense for the Central Bank to maintain it because the negative costs outlined above are much more disastrous than the gains which are expected after floating.
What are the implications of partial float?
In view of the above, captains of industry have called for partial float where a rate is pegged at say 400 percent thereby giving way for business to officially trade on the parallel market. International experience has shown that there is no market failure which can be corrected by say pegging the price of currency. The market will always move ahead, and the same captains of businesses will come back to the Central Bank with a new proposal.
What is the way forward?
In view of the need to build national consensus on this critical matter, there is need for a national dialogue. This national dialogue must be informed by evidence which is logically driven from intense research. The research show be able to show the amount of foreign exchange available both in the formal and informal market. On the back of the quantified amount of foreign exchange available, this should then help both policy makers to confidently argue for the case of floating the rate if it ever exists. In the same vein, the same dialogue must receive a cost benefit analysis (CBA) of three scenarios, that is, floating, partial float and maintaining 1:1. This approach will undoubtedly help us solve this matter logically. The risk we are having today is an emotional approach to policy issues which is not the right thing. In the absence of a robust research and a CBA, we are safe on 1:1. ◆Dr Mugano( Ph. D) is an Author and Expert in Trade and International Finance. He has successfully supervised four Doctorate candidates in the field of Trade and International finance, published over twenty – five articles and book chapters in peer reviewed journals. He is a Research Associate at Nelson Mandela University, Registrar at Zimbabwe Ezekiel Guti University and Director at Africa Economic Development Strategies. Feedback: Cell: +263 772 541 209. Email: [email protected]