Zimbabwe needs a weak currency to stimulate production, exports

Shortly after the government was sworn in August 2018, they agreed to an economic and monetary reform programme. Since then, much of this ambitious plan has been implemented and the consequences have been a sharp deterioration in living standards and disposable incomes. What has been already carried out?

First, they had to deal with the burgeoning fiscal deficit which had reached over 15% of the gross domestic product and 40% of the State budget. They raised taxes and forced all government ministries to live within their allocated resources; in a few months government was operating on a cash basis and had a fiscal surplus. Then they delinked the new forms of currency in use from the United States dollar — effectively trying to move away from the US$ as a primary means of exchange, although this created a new problem — that of price discovery — what was everything worth and in what currency?

The government then gave everyone the right to open foreign currency accounts at their bank and hold any foreign currency receipts in those accounts. At first, this was not trusted, but today — just six months later, these means of holding foreign currency are accepted. Then came the February monetary statement from the Reserve Bank. In this statement, government announced that the conversion rate of 1:1 for currency retained by the Reserve Bank for use in importing essentials was being abandoned and would in future be determined on a "willing-seller, willing-buyer" basis.

In a futile effort to restrain the movement of currency markets to a market driven rate, the Reserve Bank fixed an artificial "peg" of 2,5:1 and tried to hold the open market rate at that level.

As any student of economics could have told the government, in the absence of unlimited amounts of US dollars which the RBZ governor could supply to the markets at 2,5:1, they could never hold the rate at that level if fundamentals dictated otherwise.

In two weeks, the bank was forced to allow a daily shift and the interbank rate fell to 3:1. Then another attempt to hold the rate at that level and the market rates to 4,6:1. Everyone needs to understand where this situation puts those who actually generate foreign exchange — the miners, farmers, industrialists and tourism operators. Then there are the interests of those living in the diaspora who send home about US$10 million a day to help their families and to pay for things like medical services and education. For these interests, if we assume that about US$20 million a day is involved, then the difference in local revenue in real time gross settlement dollar (ZWL$) would range from ZWL$60 million at 3:1 and ZWL$90 million at 4,5:1. That is a margin increase of 50% — no exporter or beneficiary of diaspora remittance money can afford to ignore that sort of margin.

So, when the Reserve Bank tries, in violation of the Monetary Policy Statement in February and, therefore, unlawfully, to hold the rate at a level below what is perceived as the real rate, then those holding foreign currency balances will shift their sales of such currency to the informal market. So, over the past month, I doubt if US$100 million has been traded on the formal interbank market.

The effect of such activity is the opposite to what the Reserve Bank was trying to achieve. Price discovery is accepted as being the rate in informal markets and this then sets the rate at which local prices are determined. In many establishments, prices are listed in US dollars and the company then uses a rate — 4:1 to determine what we pay in ZWL$ or in bond notes. This has the effect of driving inflation rates even higher.

One very unexpected development is that the much despised ‘bond notes' issued as a surrogate local paper currency is actually trading at much stronger levels that the ZWL$. In fact, at 3,5 or 3,8 to 1.

But the situation is actually worse than that because trade margins in the informal sector are much higher than those levied on any formal markets and between banks. Margins of 5% to 10% on individual transactions are reported. This means traders operating in the informal market are making huge profits and are reluctant to allow the trade to move into the formal market. In this, they are in fact supported by the banks themselves.

My own view is that if the Reserve Bank had allowed full implementation of the monetary policy, this would have quickly resulted in the formal interbank market handling the bulk of the trades in foreign exchange in a transparent manner. Sales margins would decline to 1,5% or less and the commercial banks would be strengthened. Under such circumstances, I am also quite sure that market rates would strengthen to 3:1 or even less.

This would reduce market prices as soon as this was recognised as the "real" market rate. It would also allow everyone who needed foreign exchange to buy what they needed on the market through their banks. The conversion rates used by everyone for price discovery would decline to 3:1 or less; exactly where the RBZ wants rates to stabilise.

My own view is that we need a weak currency to stimulate the productive sector and strengthen export activity. If we, under these circumstances, decided to hold the rate at, say, 3,5:1, we would have to buy US dollars rather than sell them to hold the rate at a lower rate. This would allow the RBZ to build up their foreign reserves, something we are going to have to do for debt clearance in the long-term.

But what we are not facing up to is the need to mitigate the impact of these massive swings in policy on ordinary consumers. Since the programme was initiated, inflation has been at hyperinflation levels for months, and prices have doubled or trebled while incomes have stagnated.

In the previous dispensation, our export industries were being used to subsidise the prices of essential consumer items such as fuel, maize meal, cooking oil and bread. This was crippling our exporters and boosting consumption of imported essentials and thus driving up the import bill. It could not have been allowed to carry on or the country would be completely crippled.

Now we have effectively boosted the revenues of all exporters and the local receipts on Diaspora remittances by a factor of 3:4. Exporters' profit margins as expressed in local currencies have soared and tax receipts been boosted. The problems created by this strategy are massive — the "legacy" debts of all those who had thought they were trading at 1:1 and were able to secure currency at this rate suddenly found themselves in a market where they have to pay 3:1 or 4:1 for foreign exchange to settle "legacy debts" owned to parent companies or suppliers.

In addition, we are now faced with a situation where maize — currently being sold at ZWL$240 a tonne, will have to go ZWL$1 000 a tonne or more — four times the present prices. The same applies to bread and cooking oils. Fuel is already up by a factor of three. This a nightmare and has to be tackled immediately and no one wants to do so because of the consequences.

In April, government raised salaries by 18% to 30% and the private sector is now following suit. But much more is needed. We must start now to plan to raise salaries by another 25% in June and again in October. Then I suggest that the pay-as-you-earn ceiling in RTGS dollars should be raised to several thousand dollars a month to give wage earners more disposable income. Fast growth is coming in the wider economy — but will lag a bit because it takes time to get the increased capacity in place. In the meantime, we must manage the aftermath of change.

--------
Eddie Cross is a former MDC policy advisor and economist. He writes in his personal capacity.