The prospect of high inflation in Zimbabwe is high should government continue creating new money to fund fiscal deficits and quasi-fiscal operations, the new International Monetary Fund (IMF) Zimbabwe mission chief Gene Leon (GL) has warned. The Zimbabwe independent business editor Chris Muronzi (CM) caught up with the Leon last week for an interview. See excerpts below:
CM: The IMF noted that there has been a significant growth in money supply in Zimbabwe. What is causing that and is this not going to cause a rise in inflation?
GL: The increase in money supply (over 200% between end December 2015 and May 2017) is being created by the overdraft from the central bank to the government that is used to finance the large fiscal deficit. Indeed, as noted by the IMF’s executive board at the 2017 Article IV Consultation, the ongoing deficit financing modalities, particularly the credit from the central bank, are unsustainable and have significant potential for generating inflationary pressures.
CM: If so (if the growth in money supply is evident) , did you raise these concerns with the Zimbabwean authorities and what was their attitude?
GL: The authorities are keenly aware of the risks to inflation, given Zimbabwe’s recent experience with hyperinflation, and have expressed a willingness to contain the money creation.
CM: The IMF has been concerned for years with the level of recurrent expenditure in government or rather high staff wages which are consuming more than 80% of the country’s fiscal budget and the need for reforms. Do you think the Zimbabwean government is committed to instituting reforms judging by your experience in Zimbabwe and elsewhere the fund has pursued or offered such advisory services?
GL: Our experience suggests that these reforms are difficult in most cases. That said, in the case of Zimbabwe, the current fiscal trajectory is unsustainable and fiscal adjustment is thus unavoidable. Our understanding is that the authorities are working on building the political consensus needed to push these reforms.
CM: Zimbabwe is facing an acute shortage of cash. What is the root cause of the shortages and how best should this be addressed?
GL: The root cause of the cash (US dollar) crisis is the fiscal stance: with a shortfall in the supply of dollars in a dollarised economy, greater spending by the government (wider deficit) means less dollars available to the public. The lower supply of dollars comes from lower export receipts, and declining foreign investor confidence which has curtailed net capital inflows.
Further, under the dollarised system, the use of quasi-currency instruments to finance domestic transactions also requires an equivalent amount (backing) of dollars. Without an increase in the supply of dollars, the price of the quasi-instruments will reflect the excess demand; at the same time, controls or restrictions on the use of dollars contributes to reducing economic activity. Hence, there is a need to reduce the deficit and implement reforms that would increase export receipts and allow capital to flow back into Zimbabwe.
CM: The Zimbabwean government has issued Treasury Bills (TBs) running into several billions to address various funding gaps with most of the paper ending up on the books of banks.
Does this not pose concerns on the liquidity positions of banks. For instance, in the full year to December 2016, Zimbabwe’s largest bank by deposits and capitalisation, CBZ, had more than 40% of its assets in TB’s. Does this not pose risks to the country’s financial sector given the level of exposure to government debt, especially in light of the fact that government is creating money electronically?
GL: Theoretically, TBs are risk-free and liquid. Our concern is that the massive issuance of TBs in Zimbabwe has impacted this perception, with TBs now becoming increasingly illiquid and hence being discounted. These developments pose clear risks to the balance sheet of banks and the financial sector more generally.
CM: How would you describe the country’s state of the economy? And what are the prospects like going forward?
GL: Zimbabwe’s economy is facing very difficult challenges. A severe drought and slow reform momentum have led to high expenditure levels since late 2015, despite subdued revenues. Growth this year is expected to be supported by a strong performance in agriculture, mainly owing to exceptional rains.
However, economic activity in the medium-term is projected to remain subdued, pending adjustment and reform that tackle the structural challenges and enable the economy to restore fiscal and external sustainability and achieve its growth potential.
A comprehensive reform will also need to tackle the high levels of poverty and inequality.
CM: Where do you see inflation by December 2017?
GL: Our current forecast is for inflation to be around 7% by end-2017.
CM: Should the central bank not slow down on its money creation exercise (issuing bond notes to the banking public and exporters and debiting balances with RTG’s balances to government creditors), how real is the prospect of inflation?
GL: There is a risk that inflation accelerates if the discounts between the physical US dollars and the quasi-currencies widen, as the creation of money exacerbates the cash crisis. An associated issue is the fact that inflation affects the poor disproportionately more.
CM: On a scale of 1 to 10, how do you rate Zimbabwean authorities in terms of how economic management and in terms of instituting various economic (doing business, investment environment, restructuring the government work force.
GL: The authorities understand the urgency for policy adjustment to reduce the fiscal (and external) deficit(s) and the creation of an enabling business environment conducive to private sector-led growth and the unleashing of Zimbabwe’s latent economic potential.
Although government has initiated some reforms (e.g. legal changes to improve the ease of doing business), much more needs to be done and urgently to address the widening imbalances in the economy and the structural impediments to growth.