Float­ing ex­change rate will take us to 2008

The Sunday Mail (Zimbabwe) - - ADVERTORIAL - Dr Gift Mugano

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]

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