Has the Zimbabwe dollar really stabilised against the US unit?

There is a strong debate among economic analysts pertaining to whether the Zimbabwean dollar (ZW$) has stabilised against the American dollar (US$) or not. There is a section which believes that the local unit is currently stable pointing to the solid ZW$ performance in the official market since the abolishment of fixed exchange rate regime for a FX Auction system on June 23, 2020. But is it right to view exchange rate stability in isolation? Despite having thin weekly volumes than the auction market, trends in the parallel market have huge economic consequences - positive and/or negative. And, the Zimbabwean economy is more biased towards the informal sector such that businesses are benchmarking their prices on the parallel market rates. Consequently, Zimbabwe inflation highly emanates from the exchange rate market.

From 2019 through the first half of 2020 (1hY2020), the country experienced massive ZW$ depreciation mostly on the black market. During this period, the country experienced its worst economic performance since the 2008 hyperinflation. Independent institutions estimate Gross Domestic Product (GDP) to have fallen by double digits both in 2019 and 2020. The drivers of economic recession in these respective years include among others Cyclone Idai, acute foreign currency shortages inhibiting importation of key raw materials, severe energy deficit stifling industrial production, back-to-back droughts fueling food and imported inflation, massive exchange rate depreciation and subsequent rampant headline inflation.

Despite nosediving national output (GDP), liquidity (ZW$) growth ballooned as the government was facing a constrained fiscal space. For starters, fiscal space can be defined as room in a government's budget that allows it to provide resources for a desired purpose without jeopardising the sustainability of its financial position or the stability of the economy. There is consensus among economists, as explained by the Quantity Theory of Money, that if the quantity of money exceeds the quantity of output, nominal output will increase to equilibrate the market (inflationary). So, exchange rate instability and subsequent high inflation experienced during the aforementioned period, in my view, was fueled by massive reserve money (rM) growth. rM is highly price sensitive since it is injected directly and at the discretion of the Bank and also by virtue of its components which functions more as a medium of exchange rather than store of value.

Putting some statistical validation of my point above: In 2019, when reserve money (rM) ballooned by 170% from ZW$3,3 billion recorded in December 2018 to about ZW$8,8 billion as at December 2019, the local currency plunged by 85% on both the then interbank market and parallel market. In response, annual inflation outturn surged by 479 percentage points from 42,1% in December 2018 to 521% by end of 2019. Fast forward to 1hY2020, RM climbed by 30,7% from ZW$8,8 billion in December 2019 to about ZW$12,7 billion in June 2020. During this period, ZW$ gave away 70,8% of its value on the official market and 80,9% on the alternative markets and annual inflation outturn closed the first half-year at a high of 737,3% with monthly outturn averaging 17,8%.

The above period witnessed various exchange rate management mechanisms from a shortly-lived liberalised interbank market to a circuited interbank to a fixed regime. Authorities were absconding themselves and putting the blame of this severe exchange rate instability on human behaviour (speculative activities). While this was true, in my view, it was massive money printing by the same authorities against declining GDP that significantly disrupted the ZW$ value. After a policy change by the Government from fiscal indiscipline to sustainable fiscal spending coupled with tight RM targeting by the Bank and resuscitation of the interbank market in the form of Dutch Auction System, sanity was restored in the FX market and ZW$ began to stabilise against the greenback in both markets.

Between June and December 2020, the ZW$ gained 9,5% in the parallel market, shrinking the black market premium to acceptable stability thresholds of about 20%. Black market premium is the ratio of black market price to official price level. Due to the slowdown in ZW$ depreciation pressure in 2hY2020 thanks mostly to liquidity tightening, annual inflation began to subside and went on to close the year at about 348%.
Nevertheless, by that time many economic analysts warned that the ZW$ stability was fragile since the real (productive) sector was yet to fully recover from the impacts of the coronavirus pandemic. In my view, the best way to attain sustained exchange rate stability is through following basic economic principles to address domestic production deficiency thus shifting away from import dependency towards export growth. As such, I expected the government to take the warning seriously and guard against derailing the "austerity gains". however, we are now witnessing massive liquidity growth thanks in part to heightened government spending. The government via the Grain Marketing Board (GMB) is currently buying agricultural produce like staple maize from farmers for the Strategic reserve at prices far higher than import parity price (of course using the auction rate). Apart from that, the transaction was not initially budgeted in the 2021 national budget. For instance, the budget has set aside ZW$8 billion for the Strategic reserve but the government has now announced that it will spend ZW$60 billion for the same purpose raising eyebrows for money printing. The civil servants who were reportedly given a 25% remuneration increment in April are also due to receive another 45% increment this month (June). In response to high liquidity coinciding with agriculture marketing season and salary reviews, ZW$ has plummeted further in the parallel market. In April, the local unit averaged ZW$120 to the dollar in these alternative markets and is now ranging between ZW$130-135 to the same US$ , effectively putting black market premium above 50%. This continued sharp widening of the variance has prompted the government to re-introduce price controls through statutory instrument 127 of 2020.

The recent ballooning of parallel rates rightly shows disequilibrium in the FX market as the auction weighted average exchange rate becomes seriously overvalued and being somehow controlled (fully determined) by the bank. auction transparency issues arise usually when the black market premiums begin to surge to unsustainable levels. Forex demand on the official market is rising as shown by increase in allotments on the Auction. Statistics show total forex allotments jumping by 24,7% in May and forex demand remains highly elevated months ahead as the economy (production) is expected to recover from last year Covid-19 induced recession. Also, the confidence in the local currency is greatly lacking as many economic agents are trying by all means to convert a large part of their rTGS earnings to the more stable US$. So, the fact that many agents, arguably including the government itself, have zero trust in the ZW$ yet they are currently being flooded into a slowly recovering economy exerts massive depreciation pressure. Since the beginning of the year to May, rBZ has injected at least ZW$4,5 billion in new money into the economy. I think this is too much given that we were in lockdown and with reduced business hours for most part of Q1. This increased liquidity growth is the major exchange rate destabiliser and should be clamped down. Therefore, it will not be correct to believe that the ZW$ is currently stable when the parallel premiums are northwards of 50%. Conventionally, a currency is deemed stable if the variance between official and alternative exchange rates oscillates below 20%.

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