Why the cash crisis is taking long to solve

The main reason why the cash situation is taking long to solve is that solutions to address it are premised on incorrect assumptions.

Daniel Ngwira

It appears the people who are supposed to guide government in decision-making, based at the Reserve Bank of Zimbabwe (RBZ), have become politicians. Whatever step they decide to take, they think in terms of political correctness for fear or favour.

The central bank is for technocrats, while government is for politicians.

In the monetary policy document presented on August 2, the central bank claims that the US$1 billion stock of money in circulation is sufficient to support the “usable balances” when measured in terms of Real-Time Gross Settlement (RTGS) balances of US$1,6 billion.

The RBZ then blames the cash shortages on the inefficient circulation of money. The apex bank blames the informal sector and the parallel market for this situation.

In the same document, the central bank says the shortage of “foreign dollars” is mainly due to “limited access to foreign finance, declining foreign investor confidence, which has reduced capital flows and the indiscipline-induced leakages of forex through illicit transactions and other nefarious activities that include rent-seeking behaviour”.
This is not in line with the problem of inefficient circulation of money.

The central bank goes further, stating that “the root cause of excess demand for forex, on the other hand, is emanating mainly from increases in money supply as a result of greater spending by government, money-creation loans and overdrafts by banks. It is these external and domestic imperatives or fundamentals that need to addressed to bring equilibrium and resolve the challenges besetting the economy”.

Numbers provided by the RBZ governor in the recently presented monetary policy report show that domestic credit rose 21,1% to US$8,45 billion year to May 2017.

The rise in domestic credit was mainly attributed to a 38,67% growth in net credit to the government. The report is very clear that government resorted to such borrowing in the face of dwindling revenues and that the government made use of its overdraft facility as well as the Treasury Bill issuance to raise money for the day-to-day running of its operations.

As we have learnt that credit to the private sector grew by just under 2%, it becomes clear that government did crowd out the private sector and it therefore follows that it has been the major contributor to the cash shortages in the market.

Despite the fact that the apex bank argues that the money currently in circulation is enough to cater for the country’s needs, it still found it imperative to boost the bond notes by US$300 million.

Of course, this is done under the cover of a noble cause called export incentive yet we now know that bond notes have been part of the central bank’s solution to ease the cash shortages.

If indeed, the central bank believes that the main missing link in eradicating cash shortages is enhancing or improving the efficacy of money circulation, then why is it not putting in place measures that will improve currency circulation?

Also the bank stated that it “views the export incentive scheme or subsidy scheme as an important monetary policy tool for internal devaluation to deal with export competitiveness”.

Yet the RBZ is on record pronouncing to economic players that the bond notes trade at par to the greenback. There is no way internal devaluation can result in the parity level of a currency to another going undisturbed.

The statement by the apex bank that it views the export incentive as a tool for internal devaluation can be seen as an important signal that the authorities do not expect the bond notes to trade at par to the dollar.

Indeed, the central bank did acknowledge in the monetary policy statement that there were scarcity premiums ranging from 5-25%.

But how much stock of money is enough to oil the wheels of an economy? The central bank indicated that the US$1 billion in circulation was 62,5% of the RTGS balances and in its judgement this was enough to prevent the prevailing shortages. The RTGS balances of US$1,6 billion reported could be any figure and so they cannot justify any sufficiency.

What the central bank omitted to say is that the US$1 billion is a mere 7% of the gross domestic product (GDP) of the country. Neither did central bank explain why it was under pressure to bring in US$300 million worth of bond notes which could push the ratio of currency in circulation to over 80% of the RTGS balances.

As I once stated in my article titled “To what extent can central bank print money?” there is a key relationship between money and GDP.

Thus, how much money should be in circulation should be determined by the GDP rather than a set of computer balances called RTGS which in itself is one of the several variables of the level of economic activity in the country. In any case, what could stop a government from instructing the central bank to credit its account on RTGS?

Indeed, economic theory suggests that one of the reasons why households and firms hold money is transaction demand. This money is used to undertake transactions and thus entails that the rise in the level of GDP, which also translates to an increase in the demand for money to facilitate transactions.

This is what I said in my article that I have mentioned above:

As of 2017, the pound value of cash in circulation is 73,2 billion or just under 4% of the 2016 country’s GDP. On the other hand the value of USD in circulation is 1.54 trillion or 9% of the country’s GDP. This figure accounts for nearly 2% of the total notes, coins and savings and demand accounts of the global economy as at 2015 still far less than the amount of 1,2 quadrillion sitting in derivatives during the same period.

The value of US dollars in circulation of US$1,54 trillion includes the US$1,490 trillion notes which account for about 8% of the country’s GDP. In the January 2017 monetary policy statement, the Reserve Bank of Zimbabwe reported that it had issued US$94 million of bond notes into the market or 1% of the 2015 country’s gross domestic product.

The South African Reserve Bank statement of assets and liabilities as at 30 April 2017 shows total notes and coins in circulation amounting to ZAR136,760 billion or 44% of the country’s GDP. This shows an increase of 3% on the March figures which amounted to R132,296 billion notes and coins in circulation or 42% of the country’s GDP as at March 31 2017.

In addition, the country’s gold holdings in rand terms as at April 30 2017 were R67,457 billion. This compares with R66,337 billion as at end of March.

The April numbers shows a 2% growth on March numbers. Thus the value of gold is 49% cover of the April notes and coins in circulation. This entails that using the gold standard South Africa would only be able to issue notes and coins to the extent of R67,457 billion in April and R66,337 billion in March. The current scenario subsists because firstly the rand is legal tender and secondly economic players have confidence in the rand.

Using the above data, it can be noted that generally the more advanced an economy is, the less it needs to issue notes and coins in circulation relative to its GDP.

There are outliers in the above data. Firstly, the reason why the US has such a high level of notes and coins in circulation relative to its GDP is that its currency is the global reserve currency. In addition, the US dollar is used by many countries, some of whom have adopted it as a primary currency in their respective currencies.

With the above analysis I made, it therefore follows that the central bank may not have got it right that a stock of currency which is around 7% of the country’s GDP cannot be sufficient to support an economy of our magnitude. South Africa, which is more advanced than Zimbabwe has currency in circulation of over 40% of her GDP.

In the same article I said so what does it mean for Zimbabwe? This may entail that the central bank could increase the stock of bond notes to 44% of its GDP or US$6,3 billion without causing any massive shock on the economy.

However, there is a proviso here. The country could raise the stock of its bond notes gradually to 4% or US$576,8 million or increase it to 8% or US$1,153 billion.

Now let us look at the claim that the stock of money was not circulating efficiently. What does this mean and is it of any reasonable basis. There is an assumption here that the economy of Zimbabwe is divided into two; informal and formal with clear stratification and very little assumption and acknowledgement of the fact that money is by definition fungible and fluidal.

The coming in of mobile money operators in the economic sphere at a time the banking sector failed to achieve financial inclusion means that people do not have to go to the traditional banks for banking services.
In addition, the informal sector relies on the formal sector for survival. For example, a bottle store operator is in the informal sector depending on the size of the business, yet they will have to deposit their money with a beverages distributor as they order more stock.

Both the informal and formal sectors enjoy a symbiotic relationship. When major construction is ongoing, for example, the major companies operating on and off site have a direct relationship with banks yet they may obtain services from small economic players who may not even have bank accounts. The caterers who may be informal will source supplies from major producers who constitute the formal sector.

In addition, the assertion that economic agents are hoarding cash gives an impression that they are satisfied with the returns they have made to date and as such they will not be interested in reinvesting in their business or other income-generating projects.

This is fallacious. Businesses exist to make money and the more they make the more they raise their expectation of making more from business; be it a diversified business or the same line of business. What is true is that cash is no longer being banked as it used to given that it is no longer easy for banks to avail it to customers.

Thus, the authorities should take into account that households and firms, in addition to transaction demand, also demand money for precautionary and speculative purposes.

Precautionary demand entails that firms and households hold money to meet unforeseen future needs. This helps them keep going, preserve value and grow or at least navigate difficult situations.

When the authorities hear of speculation they get worried and feel taken advantage of. Inevitably, households and firms will always hold balances for what we call speculative demand. This is meant to take advantage of investment opportunities as they arise.
The extent of balances held for speculative purposes is inversely related to market returns. In cases where financial instruments including bonds offer higher returns, investors are better off investing in these instruments and thus they reduce their holdings of speculative balances.

Put in another way, we can say that the demand for money held for speculative purposes is positively related to perceived risk in alternative financial instruments. The higher the risk, the higher the balances held.

Essentially what this entails is that policymakers, instead of making noise and shouting at economic agents, must address economic fundamentals that help households and firms maximise returns.

Ngwira is a chartered accountant, former bank treasurer and former university lecturer. He holds finance and business qualifications. — daniel.ngwira@gmail.com/ cell: +267 73 113 161.