Opinion / Columnist
Unpacking floating of exchange rate by Zimbabwe
22 Feb 2019 at 10:28hrs | Views
The Governor of the Reserve Bank of Zimbabwe (RBZ) Dr Mangudya in his monetary policy statement liberalised the exchange rate that is, departing from the 1:1 position of the bond notes or real time gross settlement (RTGS) with the United States dollars. The purpose of this article is to unpack the rationale of this move and break down the implications of this move as well as showcasing areas that need to be carefully monitored by policy makers.
Conceptualising floating of Exchange Rate
By definition, when the exchange rate is floated it means that the price of domestic currency (that is the bond notes and RTGS) to foreign currency (that is the US dollar) which is the exchange rate will be determined through the invisible hand of demand and supply.
What it means is that the amount of foreign currency (that is supply) versus the amount of domestic currency chasing foreign currency (that is demand) will inform the exchange rate.
If we take the argument of the governor of the RBZ which point to the fact that there is $1,8 billion of active liquidity (which is used for transaction) in RTGS since about $8,2 billion is in treasury bills, savings bond and loans together with US$600 million, it would mean that mathematically within the framework of a floated exchange rate, there are chances that the market rate of local currency will be 1:3.
The Rationale of Floating the Exchange Rate
The rate of 1:1 undoubtedly created a number of problems ranging from creation of opportunities for rent seeking behaviour such as corruption and arbitrage opportunities emanating from distortions. By liberalising the exchange rate, the RBZ has wiped the possibilities of these ills since the distortions are removed.
In the same vein, the 1:1 presented competitiveness and viability challenges for exporters. For example, in the mining sector, those whose export receipts, that is, 50 percent of total exports, for example, were retained by the RBZ and liquidated at a rate of 1:1 in an environment where the parallel market rate was 1:3.2 was not making any economic sense. By floating the change rate, the competitiveness of the exporting sector is expected to significantly improve.
As expected in international finance, a fixed exchange arrangement repels foreign direct investment as well as inflows of remittances. One therefore hopes this new move will give a positive impetus as we drive to attract investors.
At a rate of 1:1 Government was certainly at a disadvantage when it comes to collection of customs revenue because the cost of imports in US dollar were accounted for at a rate of 1:1 thereby prejudicing Government of fiscal revenue. Under this new arrangement one expect to see duties being calculated using the prevailing exchange rate. This is expected to drive fiscal revenue upwards.
Complications in accounting, for listed companies where a firm has to adhere to basic things like compliance with law and in this case official exchange rate kicks in, it was not possible to present financial report using the parallel market rates but one had to stick to the official rate of 1:1. This situation created a false impression on the real value of the company. Now this new arrangement makes it easier for the firms to showcase the true value of the net worth of the firms, for example.
Areas which Requires Attention by Policy Makers
Like any policy, there are always possible areas which require consistent monitoring with a view of dealing with likely challenges which may arise. For consistency, it is fair that I admit that I was very pessimistic about floating the exchange rate regardless of the benefits which are explained in the rationale above. My reservations were centred on legal, shortage of foreign exchange and inflationary pressures which may ensue.
Legal, in as much as I am not a lawyer, I still want to appreciate what will happen to the debts which are owed by Government and the generality of the population, which are denominated in the US dollar.
For example, the Government of Zimbabwe took over RBZ debt as well as some debts of state owned enterprises which are denominated in US dollar and these debts are in billions of dollars. The same can be said by households who acquired loans in US dollar and have contracts in US dollar. At a rate of 1:1, in my view, there was no confusion with regards to settlement of debts because the bond/RTGS was equivalent to US dollar.
Whilst I have no doubt that the policy makers have enough ammunition at their disposal to deal with this issue, I am of the view that explanations must be well articulated and fair guarantees must be put in place so that no one loses out on this issue.
The Governor argued that the transactional liquidity in RTGS is $1.8 billion, which I agree with. This is a reasonably low amount which can guarantee us comfort that the rate can play around 1:3. The concern which arises here is what will happen if treasury bills which constitute the lion share of the $8.8 billion matures? The question which arises where is that will these TBs be liquidated or Government will roll them over?
Liquidating the TBs will definitely increase money supply and therefore put pressure on the exchange rate to rise.
If Government takes a position of rolling them over one would like to understand the implications of such move on the viability of the companies who were anticipating to finance their cash flows on the back of the maturity of the TBs.
One way of going around this puzzle is to work on building foreign currency reserves from retained export earnings by RBZ as well as driving US dollar through provision of attractive investment vehicles to the diaspora, attract investments and promote exports.
This issue of TBs and US dollar liquidity enhancement requires serious policy attention.
One of the key issues which were raised in the policy statement by the Governor relates to mobilisation of lines of credit to guarantee a reasonable exchange rate. This is good. However, over and above the lines of credit mobilisation, there is need for the RBZ to come up with a framework which will see efficient accounting and use of foreign currency.
It boggles the mind when one consider the fact that annually the country receives around $6 billion in exports, lines of credits, diaspora remittances and foreign direct investment but struggles to meet key imports requirements. Rather, 84 percent of the total foreign currency earning is wasted through imports of useless things like tooth picks, pampers, chewing gums, agricultural produce, etc.
From a policy perspective, within the framework of the transitional stabilisation programme, Government must work with the RBZ to close these loopholes with a view of saving foreign currency.
Lastly, in view of the floating of the exchange rate after the budget statement has been done and dusted one would like to understand how the Minister of Finance is going to deal with his budget especially taking into account that this move has far reaching implication on the budget, that is, expenditure and revenue?
What does it mean for the ordinary Zimbabwean
At the heart of the ordinary Zimbabweans is the questions as what will happen to their savings and of course the cost of living.
It is undeniable that the floating of the exchange rate will result in erosion of savings and pensions of the ordinary Zimbabweans. For instance, if one individual had made investments in a savings account and at one point the monies had accrued to $100 000 at a rate of 1:1. Or consider one who deposited $100,000 real dollars eight years ago and now bring in the liberalised exchange of 1:4 into account one will see that the real value of the $100 000 today is now US$25 000. The same observation applies to pensioners. This was again one of my reservations on floating. With this experience where economic agents have lost their pension twice in 10 years period will discourage savings which are key for driving investment and economic growth.
Prices and wages spiral, the move to liberalise exchange rate will definitely result in incessant calls for adjustment of wages and salaries across of sectors including Government.
Any adjustment of wages and salaries will result in price increases in the short term. In the same vein, suppliers of utilities such as water and electricity and even rates like toll gates who haven't adjusted their prices under the new exchange rate will be forced to review their prices upwards.
What is the Overall Outlook
Notwithstanding the possible setbacks which are addressed in the previous sections above, after considering the guarantees put in place by the Governor, there is hope that we can now have a better economic outlook. However, in order to continue to sustain this positive economic outlook, it is important that the issues I raised which requires policy considerations are attended to.
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: gmugano@gmail.com
Conceptualising floating of Exchange Rate
By definition, when the exchange rate is floated it means that the price of domestic currency (that is the bond notes and RTGS) to foreign currency (that is the US dollar) which is the exchange rate will be determined through the invisible hand of demand and supply.
What it means is that the amount of foreign currency (that is supply) versus the amount of domestic currency chasing foreign currency (that is demand) will inform the exchange rate.
If we take the argument of the governor of the RBZ which point to the fact that there is $1,8 billion of active liquidity (which is used for transaction) in RTGS since about $8,2 billion is in treasury bills, savings bond and loans together with US$600 million, it would mean that mathematically within the framework of a floated exchange rate, there are chances that the market rate of local currency will be 1:3.
The Rationale of Floating the Exchange Rate
The rate of 1:1 undoubtedly created a number of problems ranging from creation of opportunities for rent seeking behaviour such as corruption and arbitrage opportunities emanating from distortions. By liberalising the exchange rate, the RBZ has wiped the possibilities of these ills since the distortions are removed.
In the same vein, the 1:1 presented competitiveness and viability challenges for exporters. For example, in the mining sector, those whose export receipts, that is, 50 percent of total exports, for example, were retained by the RBZ and liquidated at a rate of 1:1 in an environment where the parallel market rate was 1:3.2 was not making any economic sense. By floating the change rate, the competitiveness of the exporting sector is expected to significantly improve.
As expected in international finance, a fixed exchange arrangement repels foreign direct investment as well as inflows of remittances. One therefore hopes this new move will give a positive impetus as we drive to attract investors.
At a rate of 1:1 Government was certainly at a disadvantage when it comes to collection of customs revenue because the cost of imports in US dollar were accounted for at a rate of 1:1 thereby prejudicing Government of fiscal revenue. Under this new arrangement one expect to see duties being calculated using the prevailing exchange rate. This is expected to drive fiscal revenue upwards.
Complications in accounting, for listed companies where a firm has to adhere to basic things like compliance with law and in this case official exchange rate kicks in, it was not possible to present financial report using the parallel market rates but one had to stick to the official rate of 1:1. This situation created a false impression on the real value of the company. Now this new arrangement makes it easier for the firms to showcase the true value of the net worth of the firms, for example.
Areas which Requires Attention by Policy Makers
Like any policy, there are always possible areas which require consistent monitoring with a view of dealing with likely challenges which may arise. For consistency, it is fair that I admit that I was very pessimistic about floating the exchange rate regardless of the benefits which are explained in the rationale above. My reservations were centred on legal, shortage of foreign exchange and inflationary pressures which may ensue.
Legal, in as much as I am not a lawyer, I still want to appreciate what will happen to the debts which are owed by Government and the generality of the population, which are denominated in the US dollar.
For example, the Government of Zimbabwe took over RBZ debt as well as some debts of state owned enterprises which are denominated in US dollar and these debts are in billions of dollars. The same can be said by households who acquired loans in US dollar and have contracts in US dollar. At a rate of 1:1, in my view, there was no confusion with regards to settlement of debts because the bond/RTGS was equivalent to US dollar.
Whilst I have no doubt that the policy makers have enough ammunition at their disposal to deal with this issue, I am of the view that explanations must be well articulated and fair guarantees must be put in place so that no one loses out on this issue.
The Governor argued that the transactional liquidity in RTGS is $1.8 billion, which I agree with. This is a reasonably low amount which can guarantee us comfort that the rate can play around 1:3. The concern which arises here is what will happen if treasury bills which constitute the lion share of the $8.8 billion matures? The question which arises where is that will these TBs be liquidated or Government will roll them over?
Liquidating the TBs will definitely increase money supply and therefore put pressure on the exchange rate to rise.
If Government takes a position of rolling them over one would like to understand the implications of such move on the viability of the companies who were anticipating to finance their cash flows on the back of the maturity of the TBs.
One way of going around this puzzle is to work on building foreign currency reserves from retained export earnings by RBZ as well as driving US dollar through provision of attractive investment vehicles to the diaspora, attract investments and promote exports.
This issue of TBs and US dollar liquidity enhancement requires serious policy attention.
One of the key issues which were raised in the policy statement by the Governor relates to mobilisation of lines of credit to guarantee a reasonable exchange rate. This is good. However, over and above the lines of credit mobilisation, there is need for the RBZ to come up with a framework which will see efficient accounting and use of foreign currency.
It boggles the mind when one consider the fact that annually the country receives around $6 billion in exports, lines of credits, diaspora remittances and foreign direct investment but struggles to meet key imports requirements. Rather, 84 percent of the total foreign currency earning is wasted through imports of useless things like tooth picks, pampers, chewing gums, agricultural produce, etc.
From a policy perspective, within the framework of the transitional stabilisation programme, Government must work with the RBZ to close these loopholes with a view of saving foreign currency.
Lastly, in view of the floating of the exchange rate after the budget statement has been done and dusted one would like to understand how the Minister of Finance is going to deal with his budget especially taking into account that this move has far reaching implication on the budget, that is, expenditure and revenue?
What does it mean for the ordinary Zimbabwean
At the heart of the ordinary Zimbabweans is the questions as what will happen to their savings and of course the cost of living.
It is undeniable that the floating of the exchange rate will result in erosion of savings and pensions of the ordinary Zimbabweans. For instance, if one individual had made investments in a savings account and at one point the monies had accrued to $100 000 at a rate of 1:1. Or consider one who deposited $100,000 real dollars eight years ago and now bring in the liberalised exchange of 1:4 into account one will see that the real value of the $100 000 today is now US$25 000. The same observation applies to pensioners. This was again one of my reservations on floating. With this experience where economic agents have lost their pension twice in 10 years period will discourage savings which are key for driving investment and economic growth.
Prices and wages spiral, the move to liberalise exchange rate will definitely result in incessant calls for adjustment of wages and salaries across of sectors including Government.
Any adjustment of wages and salaries will result in price increases in the short term. In the same vein, suppliers of utilities such as water and electricity and even rates like toll gates who haven't adjusted their prices under the new exchange rate will be forced to review their prices upwards.
What is the Overall Outlook
Notwithstanding the possible setbacks which are addressed in the previous sections above, after considering the guarantees put in place by the Governor, there is hope that we can now have a better economic outlook. However, in order to continue to sustain this positive economic outlook, it is important that the issues I raised which requires policy considerations are attended to.
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: gmugano@gmail.com
Source - businessweekly
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