Money supply and the auction rate stability

THE newly found stability for the Zimbabwean dollar adds weight to the importance of an efficient foreign exchange system and the important role it plays in an economy.

For the past six foreign exchange auctions, the local unit has firmed at between ZW$80-83 against the greenback. ere could be suspicions from certain quarters in the market in terms of the role being played by the central bank and the independence of the auction pricing mechanism, but there is no doubt that the foreign currency auction system can be sustained provided there is restraint on money supply and policy consistency.

Reserve money (currency in circulation plus commercial bank deposits and other deposits at the central bank), has significantly dropped in the past month from ZW$16,662 billion (US$201,7 million) in July to ZW$12,117 billion (US$146,7 million) as of August 2020.

e effect has been felt on the parallel market where the exchange rate has maintained at around US$1:ZW$100 in the same period. It is worth noting that the exchange rate does not need to be high for it to be deemed genuine. It simply needs to be stable long enough to foster price stability and improve market confidence.

e sharp decline of Banks’ Real Time Gross Settlement (RTGS) Liquidity at the central bank from ZW$10,696 billion (US$129,5 million) in May to ZW$8,591 billion (US$104 million) in August 2020 has been noticeable in the market as well.

Banks’ RTGS liquidity refers to the deposits that banks place in the RTGS system for the purposes of meeting their interbank transactions for account holders. e decline means that the amount of RTGS balances circulating in the economy has declined and this has curtailed the usual high demand for foreign currency on both the formal and parallel markets.

e decline in Banks’ RTGS liquidity can also be attributed to the suspension of various consumption subsidies and monetary incentives given to gold producers in the past that had a significant impact on money supply growth.

Central bank key role

e foreign currency auction system was re-introduced by the central bank in June 2020 after the failure of the interbank market and it is playing the role of foreign currency allocation as well as price determination.

To achieve price stability, the amount of RTGS circulating in the economy has to be reduced over time so that pressure on the limited foreign currency is managed.

When buyers use their RTGS balances to buy foreign currency from the auction system, the RTGS amounts used have to be cancelled out of circulation in the economy to achieve stability.

is role can only be fulfilled by the central bank which uses the foreign currency acquired from exporters to reallocate it to various producers for importation purposes, while depositing the exporters’ local account with RTGS received from the buyers of foreign currency.

However, this balancing act may not be sustainable given the fact that demand for foreign currency is extremely high and exporters are continuously pushing for 100% foreign currency retention.

erefore the central bank has to decentralise the auction system to commercial bank level and restrict itself to supervision of foreign currency movements among other functions.

e apex bank has to move away from being the main foreign currency supplier and let buyers and sellers interact independently with facilitation from their commercial banks so as to unlock the foreign currency supply side.

e confidence puzzle

Market confidence is the most important ingredient in the value of any fiat currency and the exchange rate stability. Confidence emanates mainly from government policy consistency, transparency in governance, political stability and central bank accountability on money supply and retained foreign currency.

Exporters and other foreign currency holders have to be confident that they will get a fair value for their hard earned foreign currency in the local financial market, while buyers have to be assured that they can always get foreign currency for their import needs whenever they need it and traders (and consumers alike) must be happy to hold onto their Zimbabwean dollar balances with assurance that the local unit will maintain its value in the near future.

So far, exporters are still holding onto to over US$1,2 billion in foreign currency while private businesses or individuals with over US$405 million in foreign currency accounts (FCA) have not sold significant foreign currency to the auction market.

is shows that there is a confidence deficit in the economy which will need to be addressed. In July, the Confederation of Zimbabwe Industries (CZI) pointed out that the government has to be consistent in its policies so as to instill market confidence in the foreign exchange auction system. Any adverse change in monetary policy on the part of the central bank will dent the prospects of the auction system and send the Zimbabwean dollar on a tailspin.

Foreign currency demand

Over the last 60 days, about US$150 million (mainly from the central bank) has been traded on the auction system versus foreign currency demand amounting to over US$375 million per month to import various commodities into Zimbabwe.

is means that the demand for foreign currency to sustain the local economy is not yet being met by the auction system and bulk of the foreign currency traded is circulating outside the formal banking channels. As such the parallel market still remains king in terms of meeting the needs of both buyers and sellers.

Monetary policy changes

e central bank standardised the export retention threshold for all exporters at 70% across all sectors in the economy in the mid-term monetary policy.

Further, the 30-day liquidation period of unused foreign earnings was reviewed upwards to 60 days from the day of receipt. e changes allow exporters to hold onto their foreign earnings without being rushed to liquidate or prepay for foreign supplies as was now the case.

is move brings some measure of stability and should be maintained. In order to provide liquidity to the auction system and sustain its operations, 20% of the foreign currency generated by domestic businesses is now being liquidated at the point of depositing into the local FCA account.

It is too early to tell if the 20% has reflected positively on the auction market. Small scale and artisanal miners have been getting 100% of their payments in foreign currency for Gold delivered to the central bank.

at foreign currency has not found its way to the auction system as well. Large scale producers have been clamouring for the same retention scheme from the apex bank and failure to address their concerns will continue to reflect on the gold delivered to the central bank.

e foreign currency auction system has brought a measure of price stability, however the stability can only be sustained if the exporters, holders of free funds and various economic agents get enough confidence to freely participate on the auction market.

So far the allocation and price determination mechanisms have been addressed, the next step is to look at supply side concerns. Interest rates have to be aligned to inflationary movements so as to discourage any speculatory behaviour from borrowers.

Government expenditure has to be kept in check as well through cuts on unnecessary expenditure, which does not feed directly into public service delivery or gross capital formation.

In the past, monetisation of fiscal deficits was a key contributor to the unconstitutional abuse of the central bank overdraft facility and issuance of Treasury Bills (TBs) worth over US$7,5 billion between 2013 and 2018.

More importantly, the central bank needs to desist from any measures that will grow money supply in the economy and put pressure on the exchange rate thereby erasing the gains achieved through exchange rate stability.