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Zimbabwe govt's proposed new currency reforms doomed

by Staff reporter
25 Feb 2024 at 09:27hrs | Views
THE recently proposed currency changes, intended to underpin the Zimbabwe dollar with assets, will come to nought, given that country lacks sufficient reserves to support the local unit, an independent advisory has said.

Finance minister Mthuli Ncube recently hinted on currency reforms that will see the exchange rate linked to a hard asset as part of measures to strengthen the local currency.

It is speculated that the government may peg the local currency against gold prices. It is also expected that some form of currency board may be put in place to manage the local currency.

A currency board is the effective pegging of a country's currency against that of another. It is put into effect through the holding of the later currency as reserves.

But Harare-based financial media and research firm focused on Zimbabwe and Africa, Equity Axis, said the speculated moves are technically not persuadable.

"A currency board requires the accumulation of reserves and at hand, Zimbabwe does not have sufficient reserves to implement this move. The country's deposits are now largely foreign currency denominated but these deposits are not classified as reserves," Equity Axis said.

Reserves are deliberate savings by the government through the central bank, kept in vaults against which local currency can be issued. The firm said the quantity of local currency issued, in a currency board scenario, has to be maintained at a certain ratio to the amount of reserves held for a specific currency.

This means that, for example, for local currency liquidity or balances to grow, there should first be an underlying growth in the reserves of the foreign currency against which the local unit's value is pegged.

"For a currency to earn reserves, it should have savings and these savings are earned from excess revenue against lower expenditure. For national revenue to grow, businesses should produce or report higher profit levels," the financial firm said.

"Zimbabwe has achieved growth, from a GDP perspective in recent years, but the growth is not as strong and also lacks fundamental backing."

The advisory firm said an economy will need to manage its finances well from a budget perspective. An economy that has a higher budget deficit and unsustainable debt levels may find it difficult to build reserves against which such a model needs to be anchored, it said.

Zimbabwe last held foreign currency reserves before 2008 with peak levels having been attained late in the 1990s. The erosion of reserves, according to Equity Axis, was due to economic instability which attracted opaque and untested ways of economic management, all of which failed.

"It is important to highlight that those who are speculating on this move are not anticipating a full-scale currency board but only elements. It is difficult to imagine which parts of the currency board are without the underlying asset accumulation, which in essence becomes reserves," the firm said. "In our view, the best-case scenario would be a currency board with minimum reserves and higher currency volatility expectations. This effectively means an almost ineffective currency peg."

It added: "The success of a currency board is driven by the level of reserves accumulated. Suggestions of ‘extracting elements of the model' could mean borrowing the principle of pegging currency against a certain underlying asset or assets, a hybrid version of sorts. This brings us to the second expectation, being that of a gold-backed currency. This model is against the same principle of underlying assets.

"The value of gold and the quantum of it against the total local currency will determine the value of the local unit. For the local unit to strengthen it would require the value of gold to surge on global markets or the quantity of gold reserves maintained to grow against a stable local currency quantity."

The central bank recently revealed that it has accumulated about one tonne of gold since the change in regulation requiring mining companies to pay for their royalties partially in the form of the asset mined, for example, gold.

"Assuming all the accumulated gold royalty has not been spent and kept as reserves, it would follow that in value terms, this is only about US$55 million, that is the value of one tonne of gold," it said.

"This is grossly inadequate to peg the Zimdollar against given that the level of local currency-denominated deposits is way above, at over US$1 billion equivalent. To succeed, authorities will have to demonetise the Zimdollar in circulation again, for a third time in under 15 years.

"We, therefore, conclude that the speculated moves are technically not persuadable given the challenges on the working modalities. If the government soldiers on, it will do without being sincere with Zimbabweans. This means there could be manipulation to sanitise the local currency value peg."

The local unit has maintained free fall easing on both the parallel and formal markets. It has lost 50% since the beginning of the year on the same market, the worst performance since its re-introduction in 2019.

Source - the independent