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Is foreign currency market stabilising?

21 Aug 2020 at 07:56hrs | Views
It has been nine weeks since the Reserve Bank of Zimbabwe (RBZ) reintroduced the managed float interbank foreign currency trading system. The resumption was meant to establish a formal market under which fair trading of foreign currency would result in correct pricing of the local currency.

It was also meant to remove market distortions affecting both demand and supply. Exporters, who are anchor suppliers of foreign currency, felt that they suffered significant loss of value when compelled to dispose of their foreign currency earnings at rates that were sub optimal and not market driven.

The variance reflected between the interbank price of forex and the parallel market was very wide, which discredited the formal market. The volumes traded on the formal market were therefore subsequently very low and thus mismatched relative to import demand.

Imports of key goods and services were consequently in short supply on the local market. all these factors compelled a restoration of a viable formal market for foreign currency trading. If the free market was good for all, why then did it take this long for the RBZ to accept full liberalisation of the foreign currency market, one would perhaps ask.

It was never easy for the apex bank, because government was largely running a system of subsidies across the economy. This overburdened the fiscus and forced the central bank to use its power to suppress the exchange rate so as to be able to procure foreign currency at discretionary rates.

one would consider this as a soft fixed exchange rate regime. a highly subsidised economy also forced the RBZ to sometimes print the local currency to cover the needs of the central government.

This undertaking would fundamentally rebalance the equation between the quantities of local currency chasing available foreign currency balances.

Assuming other factors are unchanged, the increase in supply of local currency would push demand for foreign currency up and thus raise its price relative to the former.

The demand for foreign currency would be further precipitated by speculative buying of forex as people seek hard currency to preserve value.

Zimbabwe formally liberalised the exchange rate in February 2019, but between then and June 2020, largely struggled to put in place a viable formal foreign currency trading market. In between the periods, inflation soared by almost 700% as it tracked the parallel market exchange rate.

Fully liberalising would have raised the cost of certain goods and services, further stoking inflation. It was a risk to the political order and any government would not take the risk without reservations and fears. But what exactly forced the RBZ and government to submit was not purity of conscience, but alternative reality drawn from the observations that the parallel market was holding sway and dictating economic direction, ahead of its own dictates on a highly regulated dysfunctional market.

Trading statistics for the eight-week trading period shows some varied observations. generally, the exchange rate has widely depreciated against the greenback. over the first eight auctions, the average weekly depreciation stood at 5%.

In the eighth week, which is the current week, the local currency depreciated by only 0,4%, the lowest weekly loss thus far. The rate of weekly value loss has been coming down over the last two weeks, a pointer towards possible exchange rate stabilisation.

However, it will not be enough to look at the rate in isolation. other technical indicators such as bid sizes, outturn of top and lower bids need to be factored in for a comprehensive and informed appreciation.

Primarily, the bid spread is the most important indicator for ascertaining possible near-term stability. The spread is the difference between the top bid and the lower bid. In successive auctions, the gap between the two reduced up to the sixth week and narrowed sharply this week. The tightening bid spread reflects expected reduced volatility or price swings.

It is a guide on buyers' perception and the range against which they expect the currency to trade at, more so at which they are ready to buy at. In a conventional market, a bid-ask spread determines projected price stability or possible price correction.

Fundamentally, sustainably rising bid reflects relatively high local currency liquidity. It increases the propensity for upward price correction in the currency. It therefore borrows from the underlying money supply levels in the economy.

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Gwenzi is a financial analyst and MD of Equity axis, a financial media firm offering business intelligence, economic and equity research. respect@equityaxis.net.

Source - the independent
All articles and letters published on Bulawayo24 have been independently written by members of Bulawayo24's community. The views of users published on Bulawayo24 are therefore their own and do not necessarily represent the views of Bulawayo24. Bulawayo24 editors also reserve the right to edit or delete any and all comments received.

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