Pegged exchange rate: A nightmare to business
Zimbabwe’s foreign currency auction platform resumed on January 18, 2022 after a five-week break. In that period, formal businesses had to make do with the last pegged foreign exchange rate of US$1:ZW$108,66 when the parallel market exchange rate moved from ZW$180 to the current ZW$230 for the same unit of the greenback during the period.
This means that prices of goods and services in the open market have gone up by at least 25% in that festive holiday period. The closure points to the irrelevance of the auction rate in determining prices in the local market. In 2021, the auction platform allocated US$1,971 billion to selected local businesses and individuals with 62% of the amount going towards importation of raw materials, machinery, and equipment. This means that the platform allocated roughly 35% of the foreign currency needed for formally importing commodities into the country, before foreign currency required for domestic operations or informal imports are factored in.
Rationale for fixing the rate
The most important role of the central bank in every economy across the globe is to manage inflation. This role is achieved through managing interest rates (in line with inflation) and suppressing money supply to align it to real economic growth. However, this role has long been sacrificed in Zimbabwe since the introduction of Bond Notes in November 2015. The country’s apex bank justifies controlling the exchange rate as being critical for managing inflation which can be triggered by wayward parallel market exchange rates. However, on the one hand, the bank has been the key architect of virtual money creation in the economy through quasifiscal operations and parallel funding of government expenditure among other non-core operations.
The bank directly funded gold and tobacco production, while subsidising consumption of various commodities from fuel, power, cooking oil, flour, mealie meal and other fast moving consumer goods. To allow this, bond notes were printed in exchange for real money in an exercise that will cost the taxpayer over US$3,3 billion in external debt. To this day, the central bank continues to justify controlling the exchange rate and price increases which emanate from its quantitative easing policies and unfavourable foreign exchange regulations. Like before, the pegging of the exchange rate is supported by external loans and other facilities where commodity exports are mortgaged. After all, the cost will be passed on to the taxpayer.
IMF recommendations
In its Staff Monitored Programme (SMP) report on Zimbabwe in April 2020, the International Monetary Fund (IMF) pointed out that the central bank was responsible for the hikes in foreign currency exchange rates on the parallel market through subsidies and gold incentives that lead to growth in money supply and pressure on the limited foreign currency.
Part of the recommendations from the IM F in 2020 point to the need for liberalisation of the foreign exchange controls as the key to financial market and economic stability. Similarly, the central bank was advised to discontinue its gold incentive scheme and funding of various subsidies in the market. The central bank was urged to develop a schedule for the removal of foreign currency allocation via the priority list and allow exporters to sell the surrendered portion on the interbank market through their respective banks. The Bretton Woods institution also recommended the removal of restrictions set on the rate at which banks can transact and the amount traded by account holders to make commercial banks market markers in the determination of interbank rates.
Impact on lending
Foreign currency deposits in local foreign currency accounts (FCA) have grown from US$352 million in January 2020 to over US$2,4 billion as of December 2021. The depositors have no incentive to convert these funds using a pegged rate lower than the accepted market rate. They are using these funds as collateral to borrow in local currency and repay less after factoring in the impact of inflation. FCA funds also remain idle because banks require guarantees (backed by law) that borrowers of foreign currency repay it in hard currency to avoid a repeat of 2009 and 2019 when borrowers repaid foreign currency denominated debts using a depreciated local currency. This would not be the case if the foreign exchange market rate was market determined. Therefore, the absence of a market determined foreign exchange rate and monetary policy consistency is negatively impacting the local credit market. Various businesses would benefit from the idle funds to ramp up production, retool and meet domestic demand.
Impact on agriculture
The exchange rate remains one of the key constraints faced by farmers who buy inputs and incur costs in foreign currency or Zimbabwean dollar prices indexed on the parallel market rates. Cotton, maize, soya, wheat, and traditional grain farmers are compelled to sell at producer prices set by the government in local currency.
The effect of inflation means that viability in farming is compromised by late payments and subeconomic producer prices. A truly reflective foreign exchange market can address these challenges faced by farmers and restore viability in agriculture.
Impact on market pricing
The spread between the auction rate and parallel market rate presents costing headaches for formal businesses who get a portion of their foreign currency requirements from the auction platform, while others use the spread to make super profits by selling products exclusively in foreign currency. The government recently highlighted that various petroleum retailers were selling fuel exclusively in foreign currency while benefiting from the auction system.
Impact on manufactured exports
Locally manufactured products face competitiveness constraints on the export market because of the high cost of production in Zimbabwe. The 40% surrender requirement on exports is eating into the slim profit margins earned by the industry. This is compounded by the fact that 20% of the local foreign currency sales deposited with local banks are converted to local currency using the pegged auction rate. Producers are now diverting most of their products to the informal market (Cash and Carry tuck-shops) where they can be paid US dollars in cash, while evading the stringent foreign exchange controls and tax obligations. The exchange control measures are also discouraging exports of manufactured merchandise in a period when Zimbabwe needs to chart export-led industrialisation in line with the Africa Continental Free Trade Area (AfCFTA). The share of manufactured exports fell from 7% in 2020 to less than 4% in 2021.
Unsustainable subsidy
Pegging the exchange rate means that the government now has import subsidies for various importers, import duties are now 50% cheaper and the central bank is also subsidising citizens to access cheap foreign currency for unproductive domestic consumption. This framework is creating an unequal operating environment across various sectors of the economy as there is no incentive to produce if it’s cheaper to import the same commodity. The indirect subsidy is unsustainable and will impact productivity in the economy once the policy is corrected.
Foreign currency shortages?
Zimbabwe’s total export receipts in 2021 jumped 38% to over US$6,1 billion from US$4,43 billion realised in 2020, while international remittances grew by over 53%. The growth took Zimbabwe’s official foreign currency earnings to a record figure of about US$7,8 billion in 2021 (Up from the 2020 value of US$6,29 billion). Despite the year-on-year growth in export earnings since 2009, the country is stuck in unrelenting artificial foreign currency shortages. Pressure on foreign currency is caused by unprecedented depreciation of the local currency which has been rendered a transitory unit of transaction, not a store of value. Additionally, re-dollarisation and low foreign currency retention levels have also created huge demand for foreign currency for local business sustenance. Every local currency account holder wants to quickly get rid of their Zimbabwean dollar and ensure future losses are kept very minimal.
The current auction system was critical to foreign currency allocation in the short term while modalities for a managed floating exchange system or efficient interbank market were being organised. The central bank has reneged on its declared principles on managing the auction system and continues to allocate unavailable foreign currency at pegged exchange rates. Zimbabwe does not have a foreign currency problem; it has an allocation problem which rests solely on the central bank (government) doorsteps. A pegged exchange rate remains the biggest deterrent to sustainable economic recovery efforts and the biggest headache to doing business in Zimbabwe.
Bhoroma is an economic analyst and holds an MBA from the University of Zimbabwe. — vbhoroma@gmail.com or Twitter: @VictorBhoroma1.