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Monetary policy inconsistency sinking economy

08 Jun 2022 at 07:19hrs | Views
On the 17th of May 2022, the Reserve Bank of Zimbabwe (RBZ) issued a circular cancelling the order announced by the head of state on the suspension of bank lending one week earlier. The head of state had earlier pointed that the presidential decree was designed to stop speculation against the Zimbabwean dollar and was part of a raft of measures to stop the depreciation of the local currency on both the controlled formal market and the alternative foreign exchange market. This means that the financial sector partly shoulders the blame for the recent run-on inflation, in as far as the government is concerned. The decree had disastrous consequences on business to a level that the central bank had to issue various circulars to justify and exempt various commodities in the market.

Lending in Zimbabwe
Zimbabwe has 13 commercial banks, 5 building societies, and 1 savings bank. In addition, there were 168 credit-only microfinance institutions, 8 licensed deposit-taking microfinance institutions and 3 development financial institutions as of 31 December 2021. For the year ended 31 December 2021, the banking sector reported unaudited aggregate profit of ZW$59.29 billion, an increase of 69.63% from a profit of ZW$34.95 billion reported for the corresponding period in 2020. Total banking sector loans and advances increased by 61% from ZW$142.79 billion as of 30 June 2021 to ZW$229.94 billion as of 31 December 2021 (6 months). Growth was largely attributed to the translation of foreign currency denominated loans. As of 31 December 2021, foreign currency denominated loans constituted 36.87% of total banking sector loans, an increase from 30.16% reported as of 30 June 2021.

Approximately, 42% of the income made by banks (ZW$25 billion in 2021) comes from lending (interest income), with the remainder coming from non-interest income sources such as POS Transaction fees, bank charges on transfers, mortgage fees, penalties, and overdraft fees. However, entirely all the income for microfinance institutions comes from lending. It is this income which was under threat and the viability of various businesses that rely on short term credit for their business operations.

History of policy meandering
After battling record-breaking hyperinflation in 2008 where inflation rate reached 79.6 billion percent per month and an astounding 89.7 sextillion per annum in December 2008, the Zimbabwean Dollar was demonetized on the 12 June 2015. The central bank vowed never to introduce a local currency until fundamental aspects such as foreign currency reserves and market confidence improve. Similarly, the government committed to restructure public debt, manage expenditure and institute free market reforms. In February 2016, the introduction of the Bond Note was termed an export incentive and solution to cash crisis. The notes were later introduced in November 2016 with a fixed exchange rate of 1:1 to the US Dollar but the introduction did not address the communicated purpose. Billions in electronic money continues to be printed. At that time, authorities highlighted that a separate account for foreign currency was not needed by account holders.

However, in October 2018, the central bank gave local banks an ultimatum to separate the so-called US Dollar accounts (Zim Dollar) and Foreign Currency Accounts (Real Money). During this period up to June 2019, the government dismissed any talk of re-introducing the Zimbabwean Dollar while Treasury and central bank authorities issued conflicting statements on monetary reforms. In February 2019, the RTGS became a currency with an official rate of 2.5 to 1 US Dollar. In June 2019, the Zimbabwean Dollar was introduced despite all fundamentals pointing south. Statutory Instrument 142 of 2019 followed to ban the use of multiple currencies and enforce the use of a monocurrency in the economy. Barely a year later, SI 85 of 2020 was passed to legalize again the use of multiple currencies. In the past 2 years, hundreds of circulars, statutory instruments, and pronouncements have been made towards the currency of use or the foreign currency exchange rate to adopt.  In all the monetary policy pronouncements, the central bank does not admit its toxic role in money supply growth, quasi fiscal operations, and failure to bring free market price discovery on foreign exchange through fixing exchange rates.

Monetary policy and consumer confidence
Zimbabwe's history is littered with the impact of money printing on inflation. Annual inflation has increased from 60.6% to 96.4% in the first 4 months of 2022. The total consumption poverty line has increased from ZW$50,976 in January 2022 to ZW$68,180 in April 2022 if conservative Zimstat figures are used. However, most civil servants and entry level employees in the economy earn salaries below ZW$40,000.
The main source of inflationary pressure on the local market is money supply growth which leads to artificial demand for foreign currency on both the formal and parallel markets. The central bank requires foreign currency to service external debt obligations (among other government needs); hence it is caught in a never-ending printing spiral. The central bank has limited interest in letting the foreign exchange rate be market driven as that will entail paying more for retained foreign export earnings and increase in prices of goods and services on the local market since there is no end on money printing.

Monetary policy and debt risk
The central bank has gone to the length of acquiring collaterized lines of credit (external debt) from AfreximBank and other financiers to support the auction allocation system. This would not be necessary if the exchange rate was market determined as it would crowd in free funds from exporters, local businesses, Non-Governmental Organizations (NGOs) and households who benefit from over US$1.4 billion in diaspora remittances. The central bank is also committing millions in foreign currency to dividends repatriation for foreign owned companies and multinational corporations (MNCs) operating in Zimbabwe. This role would be easily performed by commercial banks if the interbank rate was market determined. This has severely affected foreign investment in the country as foreign companies find it difficult to move capital in and out of the country through formal channels. With foreign debt now over US$10.7 billion as of December 2021 (excluding opaque central bank debt and the Global Compensation Deed debt of US$3.5 billion to former commercial farmers), it was not sustainable for the central bank to incur external debt to support auction system or subsidize various importers at the expense of exporters and the economy at large.

Monetary Policy and agriculture productivity

The exchange rate remains one of the key constraints faced by farmers who buy inputs and incur costs in foreign currency (or in Zim Dollar prices indexed on the parallel market rates). Cotton, maize, soya, wheat and traditional grain farmers are compelled to work with producer prices set by the government in local currency. The effect of inflation means that viability in farming is compromised by late payments and side marketing of strategic crops to middlemen will remain rife. Local farmers have started demanding payment for delivered produce in foreign currency due to the serious depreciation of the Zimbabwean Dollar. The government had set high producer prices for the 2021/22 agriculture marketing season to improve productivity and fend off side marketing of grain. However, the spread between the auction rate (US$1:ZW$258.54) and parallel market rates (US$1: ZW$420) provides a disincentive to farmers who are rarely paid on the spot. This means agriculture productivity is dependent on an efficient exchange rate that ensures viability for farmers. The government has to rely on various legal instruments to compel farmers to sell to the government every season.

Monetary Policy and trade
The huge spread between the free-market rate and the pegged auction or interbank rate is creating an unequal operating environment across various sectors of the economy with exporters (especially miners and tobacco farmers) feeling robbed. For every US$1 of export proceeds, exporters now lose at least 15 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. This means the pegged exchange rate is acting as a tax on all exports. The exchange control measures are also discouraging exports of manufactured merchandise in a period when Zimbabwe needs to prepare for the Africa Continental Free Trade Area (AfCFTA).

There is an urgent need to separate key institutions such as central bank operations (monetary policy) from political decisions. It's also vital for the government to consult key stakeholders and practice due diligence before announcing market defining policies today before changing direction tomorrow.  A long-term view on economic policy allows for stable economic growth, employment creation, investment, and business continuity. Inflation continues to wreck the local economy, subdue investment, dismantle savings and above all subdue millions of Zimbabweans to abject poverty. Policy consistency is a fundamental piece to the economic puzzle, without which it becomes difficult to attract both domestic and foreign investment.

Victor Bhoroma is an economic analyst. He holds an MBA from the University of Zimbabwe (UZ). For feedback, mail on or follow him on Twitter @VictorBhoroma1.

Source - Victor Bhoroma
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