Auction market weekly review
Trading on the weekly forex auction market resumed this week after a four week hiatus imposed by the Reserve Bank of Zimbabwe (RBZ) at the recommendation of the Monetary Policy Committee (MPC). The RBZ suspended auction trading on December 15, a day after December’s last auction trade. The RBZ said the suspension was meant to accommodate upcoming festive holidays. Trading was targeted to resume on January 11, but due to what the Bank said was Covid-19-induced failure by financial institutions to timeously submit essential information required to carry out the due diligence on auction bid documentation, the resumption was further delayed until this week.
In total the auction market missed four trading sessions (four weeks of trading) , three of which did not fall under calendar holidays. While it is typical for markets to close on respective holidays, the unusual nature of Zimbabwe’s forex market demanded a tailored approach. By design, Zimbabwe’s auction trades are widely dispersed at seven day intervals which means suspensions of trading over at least four sessions which will mean the economy goes without a formal forex market for at least a month. This has recurring consequences, once noted in years past. Trading data from 2019 to date shows that margins between the parallel market and the formal market widen more in periods where the formal market is not active or suspended. This was the case in 2020 when the Bank temporarily suspended trading. Parallel market premiums which would typically hover between 50% and 75%, would typically swell all the way to 100% in periods of formal market suspension. We would assume that the RBZ and the MPC are well aware of this recurring trend and therefore anticipated the outcome in the present instance.
Data from the latest auction shows that the weighted average exchange rate moved from 108,7 to 112,8 between the latest two auctions; these being December 14, 2021 and January 19, 2022. The depreciation rate is 3,7% between the two auctions. When spread across the four weeks over which the market was suspended, the weekly rate of depreciation deduces to under 1%. Before trading was suspended in December 2021, the weekly rate loss was seen at a higher level of 1,52% (a five week average).
From this angle, one would conclude that the Zimdollar performance has been relatively more stable in recent weeks compared to the period towards the end of 2021. This conclusion is however wrong.
The performance of the local currency in Zimbabwe always needs to be looked at in the context of the parallel market. This is because the parallel market plays a critical role in influencing the direction and performance of the former. While the extent of trading on the parallel market is not known, its contribution derived from informal sector activity is anything above 25% of total value.
The informal market, which is highly accessible to the general public and commonly benchmarked for goods and service pricing, has relatively high volumes of trades compared to the formal market. When factored in, the variance between the formal market and the parallel market exchange rates widened from 75% to 95% between December 2021 and January 2022. In fact, the current parallel market premium of 95% is the widest since June 23, 2020 when the auction market in its current form was introduced.
We are therefore witnessing the widest market disparities since early 2020 and this means arbitrage is at its highest level. Wider gaps incentivise rent seeking, slows down real sector production and drives up expectations for higher inflation.
What would the Bank have done differently?
There is acknowledgement that (the world over) markets are closed over holidays, but the duration is typically shortlived. It is unusual for any market to shut down for a month. This naturally attracts unintended consequences such as huge premiums highlighted above while putting the informal market in a prime position to influence prices and general market behaviour.
The background of economic and currency market fragility would have demanded that the RBZ acts differently. If the funds were available, there surely was no need to take a breather. Suspension of trading in a market where the populace has less trust for authorities and more so less confidence in the local currency, will result in speculation and increased premiums as the parallel rate soars.
On the outlook, our view is that 2022 will be more of the same as the prior year in terms of exchange rate performance. We do not anticipate stabilisation of the exchange rate given the general macro status. We believe the economy is still very fragile and the rebound in 2021, coming from a very low base, is insufficient to reposition the country and its gains could be rolled back by headwinds ahead of an election year. Odds are likely to favour a more hawkish monetary policy to support an expansionary fiscal policy which appeals to the electorate.
We do not see sufficient fire power from the real sector which is still hurdled with yester-year fundamental challenges such as retooling which generally puts a cap on the upside. We also do not feel encouraged by the emerging trend from the external sector, particularly the worsening trade deficit levels. This position acknowledges that the inflow of forex will lag outflow and thus dampen prospects for rebalancing.
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