Effect of normalisation of US monetary policy on Zim

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THE United States Federal Reserve raised interest rates by a quarter point last week and signalled a faster pace of increases in 2017. The normalisation of US monetary policy has implications for Zimbabwean economy which may be dire if authorities do not implement necessary economic policies.

Financial Matters: Shingai Moyo

In 2008, at the height of the global financial crisis, the US Fed had to resort to cutting its interest rate aggressively to 0% so as to boast expenditure which in turn helped overturn the recession. Cutting interests rates implied cheaper borrowing costs which led to increased investment expenditure in the US and abroad. It also led to a boom in commodity prices, especially precious metals such as gold and platinum spurring growth for commodity producing economies.

However, as the US economy improved, the US Fed has resorted to normalisation of its monetary policy by increasing its benchmark interest rate. The first hike was last year’s 0,25% hike and last week hike is the Fed’s second rate hike in seven years.

US rate hike is of importance to Zimbabwe, primarily due to the economy’s exposure to the dollar necessitated by the adoption of the US currency as an anchor currency within the multicurrency basket. Secondly, as a credit competitor in the global economy, Zimbabwe is prone to the ensuing capital movement to and from emerging and frontier markets.

Frontier markets in general, in which Zimbabwe falls under, attracted huge capital flows from developed economies particularly the US in the form of portfolio investments since 2009. This led to rapid growth in economic activity.
The average economic growth rates for Zimbabwe were double digit up to 2011 and this enhanced the economy’s competiveness and attractiveness to yield seeking investors. Since a rate hike reduces the risk adjusted returns for yield seeking foreign investors, it usually leads to withdrawal of funds from high risk markets such as Zimbabwe, a frontier market. A trend of net foreign outflows by investors on the Zimbabwe Stock Exchange since January this year may in part mirror the movement. Between January and November this year, the stock market recorded net outflows by foreign investors on a month on month basis. The portfolio reconfiguration induced demand fuelled the exit together with other market fundamentals. The country is therefore likely to experience a further reduction in foreign participation on the local stock market although weakening economic fundamentals may carry more weight in determining the course. Zimbabwe may also realise a further decline in foreign direct investment in the coming year as a result of this normalisation in US monetary policy.

The economy’s exposure to the US dollar makes Zimbabwe more susceptible to the greenback movement against other currencies. A US interest rate hike strengthens the US dollar against other currencies. Given the stance and signals by the Fed Reserve, we are likely to see sustained weaker regional currencies including the rand which will have negative impact on our manufacturing sector. The demise of the manufacturing sector is in part a result of loss in competitiveness due to weaker rand. Zimbabwe imports most of its needs from South Africa and a sustained weaker rand may derail all efforts to resuscitate the manufacturing sector. Effectively, local produce will remain less competitive to the region, and the economy will continue attracting currency vultures. This will dampen the drive towards diversification of exports, as only a few commodities will remain competitive on the global market.

Commodities’ prices generally move inversely to the dollar. Although the notion is too generalised, safe haven assets such as gold are more prone to the US dollar. Given the importance of gold as the anchor export driver for Zimbabwe, its depreciation in price as a result of normalisation of US monetary policy will further reduce export earnings, worsening the liquidity situation and balance of payments position. Efforts to externalise the greenback will likely heighten as its value appreciates and the appetite to hold other currencies locally will greatly diminish given the exchange rate losses. The case for adoption of the rand becomes less attractive as the psychology for value interplays among economic agents who will generally not opt for weakening currencies even in the multi-currency basket, which includes the rand.
Moyo is an economic and financial consultant.

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