Policy flaws chasing Forex from the formal market

It is estimated that US$2.5 billion is circulating outside the formal banking system in Zimbabwe with households, businesses and foreign investors preferring to store their hard-earned foreign currency close to their pockets. Given a conducive policy environment, the millions that exchange hands outside formal banking channels would help oil the local credit market, curb foreign currency challenges in the economy, contribute to banking sector income, tax revenues, and bring economic stability. However, sustained policy missteps continue to chase away foreign currency from formal economy. The sustained reluctance by the Zimbabwean government to institute a market-based foreign exchange system means that the US Dollar remains a priced commodity for storing value, hedging against inflation in the domestic currency and conducting trade in the economy. The disparity between the market exchange rate for foreign currency and the manipulated auction or interbank rate tells a story of denialism and the consequences of such to ordinary citizens and businesses. Currently, there are varied prices for foreign exchange with the auction rate pegged at US$1: ZW$416.3 while the interbank rate is soft pegged at ZW$429.3. On the open market, the rate has accelerated to over ZW$820 for electronic money and ZW$600 for cash (Zimbabwean Dollar). Mobile money and Foreign Currency Accounts (FCA) payments also attract different exchange rates on quotations.

Export Retention
The current export retention scheme allows exporters to retain 60% of the export proceeds and surrender 40% to the central bank. If the 60% is not utilized within 4 months, the central bank will confiscate another 25% to take the total surrender requirement to 65%. On local foreign currency sales, the bank retains 20% of all sales deposited with local banks. Ordinarily, these measures would not be a challenge if the foreign exchange rate was market determined.

With the above discrepancy between the formal exchange rate and the market rate, exporters are losing 35% of their real earnings due to the surrendered earnings. In other words, for every US$1 of exports, at least $0.35 is lost due to exchange rate disparities.  With key exporters (miners) paying taxes and electricity in foreign currency, foreign exchange regulations are a punitive tax to business viability. Considering the above, miners are calling for the review of the retention threshold to 80%.  

A closer look at Zimbabwe's neighboring shows in South Africa and Namibia, export proceeds must be repatriated within 6 months and exporters must sell 100% of their foreign currency proceeds to a bank or authorized dealer within 30 days of receiving the earnings or keep the export proceeds indefinitely in a foreign currency account. In Mozambique, export revenues must be repatriated within 90 days from the date of shipment and 30% of those export proceeds must be converted to Metical. However, exporters can keep 100% of their earnings in a local foreign currency account. In Zambia and Botswana, there are no foreign exchange controls. The common feature amongst all these countries is that the foreign exchange rate is market determined (not manipulated by their central banks) and they do not face acute foreign currency shortages on the formal market.

Local FCA deposits
For businesses that deposit their sales proceeds in local Foreign Currency Accounts (FCA), the central bank converts 20% of the deposit to local currency and an Intermediated Money Transfer (IMT) Tax of 4% applies to any payments made from that FCA account. This means that for every US$1 deposited, US$0.10 is lost due to the flawed exchange rate policy. Due to the above, large businesses are finding ways to transact in cash and avoid punitive taxes by not banking all sales proceeds while most small businesses and informal traders do not bank their proceeds. Despite this, US Dollar deposits with local banking institutions have grown from US$570 million in December 2017 to over US$2.2 billion as of June 2021 due to the growth in export revenues and the need to preserve value.

Endless Money Printing
The growth in money supply largely emanates from the central bank quasi-fiscal operations, export retention credits (virtual money creation) and other off budget financing programs which have an effect of creating artificial demand for foreign currency. As export revenues continue to soar, the central bank must print more money to credit exporters for the 65% in retained export earnings. According to latest figures released by the Zimbabwe National Statistical Agency (Zimstat), between January-April 2022 export earnings stood at US$2.13 billion, representing a 39% increase from US$1.53 billion recorded same period in 2021. This means that from the average retained export proceeds of US$265 million per month, the central bank must print Zimbabwean Dollars (electronic money) worth at least US$150 million every month. The Auction allotments (Averaging US$110 million per month and in over 3 months backlog) can be settled from the balance and the 20% retained on FCA deposits.

These rough estimates partly explain why the local currency has been on a tailspin and demand for foreign currency remains astronomic. The increase in domestic money stock is not matched with economic output growth. Every economic agent quickly converts their excess local currency to foreign currency to curb losses and say clear of overnight policy changes. The central bank is highly in debt with key lenders such as Afreximbank owed billions that need repayments in each month. To add to the high demand for foreign currency, government obligations abroad also need foreign currency, hence the central bank needs more cheap foreign currency than ever before.

Surging Forex earnings
In 2021, Zimbabwe earned a total of US$9.7 billion (Up from US$6.3 billion in 2021) in foreign currency with export proceeds growing by 66.6% to US$6.2 billion and Diaspora Remittances increasing 42.7% to US$1.430 billion. The major contributors to export earnings growth being the surge in gold production (from 19 tonnes in 2020 to 29.6 tonnes in 2021), the rally in mining commodity prices on the world market and the added value of exporting beneficiated PGM metals. Gold production in 2022 is expected to reach 40 tonnes. Despite the year-on-year growth in foreign currency earnings from as far back as 2009, the country is stuck in man-made foreign currency shortages. Thus, Zimbabwe does not have a foreign currency problem, but it has a foreign currency allocation problem which rests solely on the central bank (government's) foreign exchange regulations and policies. Pressure on foreign currency is caused by unprecedented depreciation of the local currency (which emanates from money printing), a manipulated foreign exchange system and dollarization of the economy.

Need for reforms
To ensure currency stability, the central bank must end all quasi-fiscal operations which will enable it to freeze money printing and institute a market determined exchange rate through either allowing commercial banks to manage the Auction system. Alternatively, commercial banks should be allowed to adjust exchange rate according to demand and supply mechanisms. On constitutionalism, the central bank must not be allowed to contract any foreign debt without parliamentary approval as this brings conflict on how to settle the debt while allowing the exchange rate to be market determined. However, sustained stability can only be guaranteed by giving the central bank independence from government in terms of money printing. History has proved that the government has no hesitation to print money to fund its expenditure and meet political objectives at the expense of the economy or the taxpayer (citizens and business).

Zimbabwe has not had a consistent currency or consistent foreign exchange policy for several decades. The country's central bank quasi-fiscal operations and deficit financing of the fiscus have necessitated astronomic levels of money printing at whatever cost to the nation. The economy collapsed in 1999-2000, 2006-2008 and 2019-2020 due to hyperinflation. The country has entered yet another phase of hyperinflation with month-on-month inflation now suspected to be over 50% by market analysts.

At the core of the problem is the government's desire to control the central bank monetary policy and print money whenever tax revenues fall short of targeted government expenditure. Between 2015 and 2021, the country promulgated hundreds of statutory instruments (temporary measures) aligned to monetary policy and produced a plethora of exchange control regulations or statements. Some statutory instruments contradicted each other while some just fizzled out before parliamentary ratification. Monetary policy consistency is a fundamental piece to the economic stability puzzle, without which the country will not develop regardless of how colorful economic blueprints can be. The preference to trade in hard currency and in cash points to lack of trust in the central bank's unsound policies over the years.  

Victor Bhoroma is an economic analyst. He holds an MBA from the University of Zimbabwe (UZ). Feedback: Email vbhoroma@gmail.com or Twitter @VictorBhoroma1.