Productive Sector Funding better gone soon than later

SO as announced in the previous Monetary Policy Statement (MPS) by the Central Bank, the Productive Sector Funding facility is being wound down come 30 June 2005.



>Despite $2,5 trillion (Jan 04-Dec 04) having been disbursed last year, and probably more so far this year, this facility has, as acknowledged by the Central Bank governor himself yesterday, not delivered the required results.

Monies disbursed were used not for the intended purpose of boosting production and thereby achieving a favourable “supply response”.


Rather the funds were used, firstly, to convert expensive market related borrowings to the cheaper PSF, initially at 30% and later reviewed upwards to 50%. These funds were also used for working capital and maintenance capex, as opposed to increasing capacity as was desired by the authorities.


Given the collapse experienced in demand following the spike in interest rates around the time of the first MPS in late 2003, this was to be expected, as companies would not have been in a position to push volumes into the market anyway, with retailers sitting on huge stockpiles which they now wanted to offload given a rise in the cost of holding stock, whilst pushing volumes via exports was becoming less and less viable due to the relatively static auction rate.


Given these conditions, inevitably money also found its way onto the money market where significant arbitrage opportunities existed, a feature of any market where a rate mismatch exists. The source of these PSF funds was statutory reserves of mainly commercial banks, these having been increased substantially during 2004 to 60% of all current account deposits, and a lower rate of 37,5% for other deposits not classified as savings.


So whilst on the one hand the RBZ claimed to be removing excess liquidity via the statutory reserve requirement, it would then dole this cash out at the concessionary low interest rates, thereby defeating the purpose of trying to control money supply. As alluded to above, this took place in an environment where there was no corresponding supply response, thus leading to inflationary pressures once again taking hold of the economy, as “too much money chased too few goods”, the classic intuitive definition of inflation. A look at the escalation in asset prices, be it stock market prices, property prices or the parallel market rate, is a clear indicator of this.


Thus the experiment with a dual interest rate system proved ineffectual, and it was expected this would come to an end in June 2005 when “convergence” would be achieved. Whilst the Central Bank has confirmed that the PSF will come to an end, convergence has been deferred once again, this time to December 2006. Instead the authorities have deemed it fit to “repackage” the PSF in other forms, this time at even lower interest rates, (5% for exporters and 20% for the agricultural sector and a mooted National Housing Facility). Borrowings for all other activities will be at market related interest rates, which with the bank rate going to 170% unsecured, suggests upward adjustments to the minimum lending rates as banks attempt to protect their margins, (and indeed ensure survival!).


The continued pursuit of this dual interest rate policy defies logic, especially when previous attempts have shown this to be ineffectual. Pumping in of this cheap money simply results in additional credit being created given the attractiveness of the interest rate, as even those export companies that wouldn’t normally require borrowings would be encouraged to borrow, thereby fuelling money supply growth. This is why the IMF has repeatedly expressed concern with the dual interest rate approach, as the distortions inevitably lead to a rise in inflation.


Whilst the Central Bank commendably wants, as do we all, to see a return of the economy to better days, the approach is unfortunately somewhat disjointed. Essentially what the authorities have and are still attempting to do is pursue both an expansionary monetary stance (eg: PSF), and a contractionary one (eg: pushing up the bank rate to 170%) simultaneously and hoping this achieves the desired result somewhere in the middle.


It would make more sense to first tackle inflation by swallowing the bitter pill and allowing rates to converge at market clearing levels, which would eventually lead to price stabilisation and provide some support to the local currency. (I stress the word some as ultimately, the country does not generate enough currency to meet its requirements, and until such a time as the political climate changes to encourage FDI and a return of international financiers such as the IMF, the currency will always remain under pressure). Once inflation is under control, then an expansionary stance could be taken to again encourage consumption and then trigger the corresponding supply response. After all, expansionary policies are generally pursued in low inflation economies to stimulate demand to avoid a recession, not in hyperinflationary ones!


This would in all likelihood prove more successful than the current piecemeal efforts that unfortunately only serve to defer the inevitable. The pill will have to be swallowed, better to swallow it now wholesale to really get the economy on track. — Special Correspondent.