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Sustainable reforms now key to foreign exchange market

08 Oct 2021 at 18:03hrs | Views
The Reserve Bank of Zimbabwe (RBZ) recently announced that it is on course to clear the backlog of foreign exchange auction allotments which date back to as far as three months and amounting to about US$270 million. The bank further pointed out that going forward, all auction allotments will be paid within two weeks from the auction date instead of the 48 hours (T+2) it communicated in June 2020 when the foreign currency allocation platform was launched.

The announcement comes in the wake of a widening spread between the formal auction rate (now US$1:ZW$88,55) and the parallel market rate (now US$1: ZW$180). The increase in the parallel market exchange rates informs the increase in consumer prices and inflation with month-on-month inflation for September increasing to 4,73% from the 4,18% recorded in August 2021.

Auction system abuse

The central bank pointed out that part of the foreign currency backlog is attributable to malpractices by certain businesses that sponsor multiple bids under the auction system.

The bank has also been releasing a list of citizens accused of using mobile money services to trade in foreign currency and launder the proceeds illegally. In doing so, the bank shifts the blame for the inefficient foreign exchange platform and harm caused by the pegged exchange rate to businesses and ordinary citizens. This absolves the government from instituting reforms that ensure a sustainable foreign exchange market liberalised from central bank command and benchmarked on other African countries that have managed floating exchange markets.

With the premium now over 100%, accessing foreign currency from formal channels and selling it off on the parallel market has become a lucrative business at the expense of exporters. Even corporates with huge foreign currency deposits and foreign currency inflows from sales find it economic to bid for cheap foreign currency on the auction system.

Punishing exporters

The huge spread between the free market rate and the auction rate means that the government now has import subsidies for various importers and the central bank is also subsidising citizens who access cheap foreign currency from the banking sector. For every US$1 of export proceeds, exporters now lose at least 20 cents on surrendering 40% to the central bank under the current export control regulations. This is before various taxes, levies and license fees charged in foreign currency apply to the exporters.

Under such a scenario, exporters will find ways to smuggle their commodities out of the country or to under-declare their proceeds which hurts tax revenue collection and creates endemic corruption syndicates in the economy. Over time, the exchange control measures hurt exports, especially manufactured merchandise.

Cost benefit analysis

To fund the auction platform and clear backlogs, the central bank relies on various external loans from institutions such as the Africa Import and Export Bank (Afreximbank).

In May 2021, it was reported by the treasury that the central bank owed over US$1,7 billion to Afreximbank borrowed between December 2017 and December 2020. This figure is only the publicly declared debt and a portion of the central bank debt used mainly for quasi-fiscal activities such as procuring various commodities (fuel, grain, agriculture inputs, etc) and supporting the auction system. The central bank would not need to borrow foreign currency to support the auction system if the exchange rate was market determined as exporters and foreign currency holders would voluntarily source forex on the formal market.

Currently, exporters, foreign missions, businesses and private account holders are holding onto US$2 billion in their foreign currency accounts. Similarly, households that receive over US$1 billion in diaspora remittances per annum would offload it on the formal market. The informal market and various other businesses that trade in hard currency are suspected to trade over US$2 billion circulating outside the formal banking channels due to punitive exchange control regulations where 10% of foreign currency is lost on every US$1 deposit in the bank.

The amount circulating on the informal market could be significantly higher considering the fact that Zimbabwe's informal sector now constitutes over 70% of the country's output.

Sadc benchmarks

South Africa operates a managed floating exchange system where the South African Reserve Bank (SARB) only intervenes in rare circumstances to Rand volatilities through open market operations. The SARB monetary policy binds all markets under the Common Monetary Area (CMA) which links South Africa, Namibia, Lesotho and Eswatini into a monetary union.

The SARB conducts open market operations to manage liquidity in the market and maintain a structural shortage of the Rand. These include issuing debentures, implementing reverse repos, moving public sector funds between the market and conducting money market swaps in the foreign exchange market.

In South Africa, exporters must surrender 100% of their foreign earnings to a commercial bank or an authorised dealer within 30 days of receiving the foreign earnings or keep the export proceeds indefinitely in a foreign currency account.

Proceeds are converted to Rand using market rates if the exporter has no forward cover contract which fixes the exchange rate. All export proceeds must be repatriated back to South Africa within six months except for special occasions where the SARB approves otherwise.

In Mozambique, there were suspicions that the central bank had fixed the exchange rate for two weeks in May despite the fact that the country employs a market determined rate. Export proceeds must be repatriated back to Mozambique within 90 days, though all exporter categories can keep 100% of earnings in local Foreign Currency Accounts (FCA) for liquidation at market determined rates when the need arises.

Zambia (with over US$1,4 billion in reserves as at May 2021, a market determined auction platform is used. The Bank of Zambia (BoZ) participates in open market operations to either build up reserves or to smoothen exchange rate volatility. Currently, there are no controls on the repatriation of export earnings and on capital flows in Zambia.

The same applies to Botswana which ranks as one of the most transparent and well-governed economies in sub-Saharan Africa. All these countries do not have endemic foreign currency shortages that Zimbabwe faces on the formal market.

Central bank role and conflict

Zimbabwe's central bank is responsible for formulation and implementation of monetary policy, directed at ensuring low and stable inflation levels. However, the central bank often engages in quasi-fiscal activities and funds government expenditure thereby unsustainably increasing money supply in the economy.

The bank is conflicted in that it requires cheap foreign currency from exporters to repay its legacy debts and fund government expenditure. The bank is also afraid of losing control of the fight against inflation if market forces determine prices in an economy where part of government expenditure is funded via money printing.

Therefore, pegging the exchange rate supports its immediate objectives. The apex bank recently announced that in order to further tighten money supply in view of increasing inflation; it has introduced special exchange-rate-linked corporate open market operations bills so as to deal with growth in money supply. These bills will be targeted at corporates with huge local currency balances or those receiving huge payments in local currency, as some of these funds are being used to destabilise the foreign exchange market.

Ordinarily, this would not be a problem to the affected corporates if the central bank did not peg the exchange rate or grow reserve money at proportions that are not in sync with economic growth.

Zimbabwe's auction platform has proved to be inefficient because of the overarching role of the government in pegging the exchange rate, auctioning foreign currency which is non-existent and lack of transparency on the available foreign currency to be auctioned.

The central bank must emulate basic tenets of central bank intervention by using policy incentives and market instruments to mop up excess liquidity.

Similarly, reducing inflation can only be achieved sustainably through restricting money supply growth. The parallel market cannot be eliminated without instituting free market reforms and curbing unrestrained foreign currency supply. An auction system is critical to foreign currency allocation, but its importance is only limited to how efficient it is in terms of allowing free market price discovery.

There is a need to craft a sustainable plan which ensures that Zimbabwe moves to a managed floating exchange rate as is the case with several African countries with comparable economies and balance of trade positions.

A pegged exchange rate remains the biggest deterrent to sustainable economic recovery efforts and a time bomb which the government is avoiding at all costs even if it means sinking into external debt levels that far outweigh the benefits of pegging the exchange rate.

Bhoroma is an economic analyst and holds an MBA from the University of Zimbabwe. — or Twitter: @VictorBhoroma1.

Source - The Zimbabwe Independent
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