Mystery of Zimbabwe's forex market

"Zimbabwe's tobacco sales have reached a record high of 237,1 million kg with a week to go before the selling season ends, official data showed" - Reuters (July 23 2018).

"Gold deliveries to Fidelity Printers and Refiners (FPR) for 2018 hit a record 33, 2 tonnes up from 24, 8 tonnes the previous year as Government led stakeholder efforts to upscale production begin to bear fruit." - Fidelity Printers and Refineries.

"Foreign currency shortage a threat to Zim industry." - Zimbabwe Independent, February 8, 2019

The Zimbabwean economy is a true paradox. On the one hand you have official production of gold and tobacco - the country's two biggest forex earners - hitting record highs, but on the other you have the economy experiencing currency shortages, resurgence of fuel queues and a return to double-digit inflation last seen a decade ago - all in the same year, 2018.

One can be excused for being a little bewildered as to how the economy can hit such peaks and troughs, almost concurrently. It does beg a few questions - just how much forex does the country require? How much are we generating? And how do we permanently rid ourselves of these problems?

Local policymakers have targeted export growth as a strategy to attain long-term foreign currency stability, offering various export incentives. The country's exports have responded, reaching US$4,7 billion in 2017, up from US$1,9 billion in 2009 - an average annual growth rate of 16%. The overall economy grew at an average 8,7% during the same period.

How adequate are these levels of exports for an economy the size of Zimbabwe though? How do the numbers stack up when compared to other countries that have experienced strong economic growth and have relative foreign exchange stability?

The graphs presented here show Zimbabwe's official exports accounted for 21,4% of the country's reported GDP figure of US$22 billion for the year 2017. This compares favourably with countries like Kenya, Rwanda and Uganda, who generate comparatively less export earnings relative to the size of their economies. Rwanda, for instance, a darling of investors, generates less than US$1 billion in exports — just 8,8% of GDP. These countries have currencies that are fairly stable, compared to our local pseudo currency, the RTGS$.

At 9% of GDP, Zimbabwe's net primary and secondary income (which accounts for diaspora remittances as well as NGO receipts) are also comparatively high relative to its economic size. The country has "exported" a fairly sizable amount of labour to the diaspora. Official remittances from this group are in the region of US$1 billion annually. Of the countries studied, none receives more income from remittances and NGO flows relative to their economic size than does Zimbabwe.

Add the fact that the above numbers for Zimbabwe record only official flows and omit illicit gold exports and unofficial remittances, the picture of Zimbabwe's exports and currency woes becomes all the more perplexing.

The country received US$1,3 billion in 2018 from official gold sales through Fidelity Printers and Refiners. It is common cause that Zimbabwe's borders are quite porous. Because gold has a high value relative to volume, it lends itself perfectly to illicit cross-border movement. Some estimate that gold illicitly smuggled out of the country totals around 50% of the official gold deliveries.

Estimates of Zimbabwe's immigrant population in South Africa range between two to three million, 80% of which are undocumented. Taking the lower estimate, undocumented workers totalling around 1,6 million find it difficult to remit money back to Zimbabwe through formal platforms and therefore rely on informal channels of remittance. Assuming each of the 1,6 million remits an average R500 (US$35) monthly, you are looking at no less than R9,6 billion (circa US$685 million) annually in informal remittances from South Africa.

It is therefore not unreasonable to estimate the total figure of unrecorded flows from illicit gold and informal remittances at US$1,5 billion annually, a figure that in part compensates for Zimbabwe's relatively low FDI flows, which are quite low in comparison to peers. Combined with official flows, Zimbabwe's total exports and incoming current transfers are likely in the region of US$8,1 billion — 37% of reported GDP.

At slightly under 30% of the GDP, the level of Zimbabwe imports, whilst high, are by no means an outlier when compared to the other countries studied. As a country, we are not importing a disproportionately high amount of goods and services in comparison to our peers.

It is quite apparent that Zimbabwe's exports are performing well on a relative basis, and the level of its imports is within range of the sample of countries studied. There does not appear to be a deep weakness in Zimbabwe's forex generation capacity given the size of our economy, yet the country finds itself in the quagmire of a pseudo currency inexorably plummeting in value.

The root cause of Zimbabwe exchange rate instability must stemming from exogenous factors outside of its exports and imports. Any trade imbalances would be expected to result in a gradual depreciation of the local pseudo currency, not the 200% plus collapse that we have experienced over the past 12 months. To a great extent, the cause of the collapse in the local pseudo currency lay in the growth in money supply that the Zimbabwe economy experienced over the past three years.

During the period 2016 through 2018, Zimbabwe's money supply grew from US$5,6 billion to US$10,3 billion, an average annual growth rate of 27,9%, dwarfing all its peers. Government's fiscal indiscipline and issuance of Treasury Bills being the major driver of this aggressive growth in money supply.

In truth, the recent collapse is more a correction that has been several years in the making. Although the RTGS$ and US dollar were officially pegged at 1:1, the Zimbabwean economy ceased being a pure dollarised economy as far back as 2014. What we have witnessed in recent times is the markets fully pricing-in this realisation, after the official uncoupling of the pseudo currency and US dollar fixed at par rate.

As the US$/RTGS$ exchange rate has corrected, everyone holding RTGS$ has suffered erosion in value. A natural reaction to this RTGS$ depreciation has been a spike in safe-haven demand for the US dollar and other foreign currencies as people increasingly hold the US dollar as a store of value and only use the RTGS$ for transactional purposes. People are just not confident in maintaining balances in RTGS$ for fear of losing value.

Confidence is critical when it comes to currencies and the foreign exchange market.

This lack of confidence in the local pseudo currency means that the demand for foreign currency is comparatively higher in Zimbabwe than it would be for a peer country with essentially the same export/import fundamentals.

Ordinarily, forex demand in other countries is solely a function of imports. Put differently, in peer countries, someone only requires forex when they wish to import something or travel whereas in Zimbabwe everyone wants to hold forex even though they may not necessarily have anything to import or are not travelling, which means that those who do have a need to import or travel find it difficult to access the forex they require to do so.

What has not helped is the lack formal intermediation in the foreign exchange market until the 2019 monetary policy promulgation of the interbank forex market. That space has up to now been occupied by informal traders without the financial nous to price currencies, with the effect that prices have often carried disproportionate premiums.

Of concern is the fact that over the course of the next few years, Treasury Bill maturities are expected to dump additional liquidity into the market, further spurring money supply growth. As of December 2018, outstanding local debt amounted to RTGS$9,5 billion, the bulk of which comprises Treasury Bills.

To stem the slide in the US$/RTGS$ exchange rate, local policymakers must infuse confidence back into the currency market and make the RTGS$ attractive. A return to positive real interest rates from negative territory would be a good start.

Money supply growth has to be reined in and government needs to walk the talk on austerity measures and fiscal consolidation. The interbank forex market should be left to find a level that is market-determined, free of any central bank interventions or shackles.

Authorities clearly have a lot to do if they are to bring medium-term stability to the local pseudo currency.

Invariably, though, a stitch in time does save nine. So the sooner they take decisive measures the better.

Chigogwana, Sikhosana and Mashozhera work for a local financial institution.