Distorted exchange rate choking the economy

ZNCC-chief-executive-Chris-Mugaga.jpg

CHRIS MUGAGA
economist

RISK perception is a major challenge in our economy. Among many other transformations which will be laid out in this paper, various policies must be reconciled to create a conducive business operating environment that will attract both domestic and foreign direct investment.

The Zimbabwean economy has been on an unsustainable economic trajectory for a long time now. Although the 2018 elections promised an economic turnaround, they further placed a financial burden on the economy. Furthermore, the polarised socio-political situation after the June 30 elections plunged the economy into further peril as political leaders struggle to find the adequate social, political and economic healing that the nation desperately needs.

Liquidity challenges first surfaced in 2014, when the Reserve Bank of Zimbabwe (RBZ) reduced cash holdings in nostro accounts from 30% to 5% of total deposits, all in an effort to improve the availability of cash in the economy. This decision led to externalisation of the dollar cash, thus exacerbating the liquidity crisis.

As the liquidity crisis continues, the central bank has tightened the screws in an attempt to manage the liquidity and, in the process, the productive sector has been complaining that it is not afforded enough foreign currency priority allocation, further curtailing its productive capacity. According to the latest figures by the RBZ, broad money supply registered a yearly growth of 30,96%, from US$7 687,23 in October 2017 to US$10 066,46 million in October 2018.

On October 1, banks were shockingly ordered to separate nostro Foreign Currency Accounts (FCAs) from the Real-Time Gross Settlement (RTGS) deposits. This directive from the government meant that the nostro FCAs are solely for United States dollars while the RTGS accounts are for electronic money and bond notes. This caused a ripple effect in the market, more specifically the dominant parallel market where the USD: bond exchange rate escalated to trade at US$1:6 bond, although the government rigidly maintained that the US$ and bond are 1:1.

Moreover, according to the central bank governor, the relationship between the two categories of FCA accounts shall be parity (1:1). The essence of this decision was to preserve value for money for the banking public and investors during the transition to a more market-based foreign currency allocation system that would be implemented once economic fundamentals are appropriate to do so.

On the same day the Minister of Finance and Economic Development introduced a Transitional Stabilisation Programme (TSP) document in an effort to reverse the impact of government activities that were crowding out private sector investment by borrowing heavily in the domestic market. However, if the private sector and the government do not come to terms, and if the government does not reduce expenditure, the TSP and the 2019 National Budget will not yield results.

Challenges and solutions

1. Fiscal Policy — Mismatch between Government expenditure and revenue.

In 2017, the fiscal deficit stood at US$2,8 billion, which is 8,4% of gross domestic product (GDP). In 2018 between January and September, overall expenditure was US$6,3 billion against the planned expenditure of $4,1 billion, according to Treasury. The deficit for 2019 is projected to be US$1,57 billion, 5% of GDP. To finance the deficit, the government has been resorting to bank overdrafts. The unsustainable government expenditure poses the single biggest threat to economic performance.

Recommendations:

  •  While we take note that there are efforts to manage the fiscal deficit, mismatch between government expenditure and revenue, we implore the authorities to protect the economy by adopting a cash-budgeting fiscal stance. This will reduce the government’s over-reliance on the banking sector to finance fiscal imbalances.
  •  There is need to revise the RBZ Act to prevent bank overdrafts by the government.
  •  All Treasury Bills to be issued must get approval from Parliament as opposed to the Accountant-General. According to the Finance Minister, TB maturities in 2019 are estimated at US$2,2 billion, which is unsustainable in one year.
  •  Treasury must develop a culture of consultation with the private sector before effecting policies for an example intermediate money transfer tax (2%) as well as the fuel tax rebate.
  •  Laws must be amended immediately before year-end, to allow the Minister of Finance and Economic Development to co-share the Master General Position with the Public Service Commissioner.
  •  All loans procured must be made public information and must be approved by Parliament.

2. Distorted Exchange Rate System- Preserving the value at the current exchange rate of US dollar and bond at 1:1.

It was announced in the 2019 National Budget that the country is still using the multi-currency system, which was put in place by government in 2009 and that the US dollar is our reference currency, also applying to the 2019 budget. The budget also stipulates that government commits to preserving the value of money balances on the current rate of exchange of 1:1, in order to protect people’s savings and balance sheets.

The overvalued 1:1 parity exchange rate between the US$ and the bond note has been causing major challenges in the market. This stance by the government continues to sideline market forces from playing their role in determining the real exchange rate, thus causing chaos in the economy. In the informal sector where the US$ is being sourced by many traders, the US$: bond rate is at a minimum of 1:3, although the figures have been fluctuating rapidly since the last quarter of 2018. The exchange rate is distorted, given that on the market the US$ is trading at a premium against the bond to the current parity between the USD and bond notes, thus creating inflationary pressures as well as note, Mobile Money Payments and RTGS. Unsustainable money supply growth is the biggest threat promoting black market trading.

Recommendations::

  •  There is need to put structures in place to ensure re-dollarisation as the exchange rate parity is weighing on business, the three-tier pricing system in the market is a response to distortions existing in the market. When the gap is corrected, the arbitrage opportunities will be eliminated.
  •  The government should allow market forces to determine the exchange rate or adopt the average exchange rate since October 1 2018 when market distortions were experienced emerged.
  •  The fiscal deficit-to-GDP ratio should move to 5%.

3. Government interventions and market controls.

Notably, market controls have never worked in this economy. The government’s hand is dominant in all economic activities, thus hinders the market forces and private sector players to make effective business decisions.

Recommendations:

  •  Fuel pricing should be dealt with by the Zimbabwe Energy Regulatory Authority, as the regulator.
  •  There is a need to de-criminalise forex trading.
  •  Wage negotiations should be a dialogue between trade unions and the Treasury.
  •  There is need for a sunset clause on the foreign currency allocation committee, banks must take-over the duty of forex allocation.
  •  Government should make it easier for business to import products, more specifically those who lost their products as a result of looting during the recent stayaway.

4. Monetary Policy – Broad Money Supply

The Zimbabwe National Chamber of Commerce has been calling for fiscal and monetary authorities to protect the economy by curtailing quasi-fiscal activities of the RBZ as well adopting a cash-budgeting fiscal stance. To contain broad money supply growth and its distortive impact to the economy, quasi-fiscal activities should be minimised at all costs and overdrafts must be limited to a maximum of 5% from 20%. While there has been the establishment of the Foreign Currency Allocation Committee, it is important to note that forex challenges are a symptom of fundamentals which need to be addressed. These include fiscal deficit, current account deficit, and confidence deficit. These factors repel FDI as foreign companies do not want to operate in an environment where the foreign currency issue is volatile. Industry is failing to import raw materials because of foreign currency shortages hence negatively impacting the country’s production levels.

Recommendations:

  •  Allow for interbank trading of foreign currency.
  •  The forthcoming Monetary Policy should provide the maturity, tenure, interest rates and holders of Treasury Bills (TBs) in the market.
  •  Relax capital controls by the central bank e.g. there is need to revise upwards the maximum amount of US$2 000 carried out of the country to US$10 000.
  •  Strengthen the independence of the central bank so that it does not pose as an extension of the treasury, e.g. governor should not be involved in fiscal decisions.

5. Communication

The rate at which conflicting statements are received on a number of areas as well as battles by government authorities using the media has been a source of worry. Conflicting statements are a cost to business as they raise the risk profile.

Recommendations:

  •  Shun/avoid reckless pronouncements.
  •  There must be presidential roundtable gatherings with business every quarter.
  •  There is need for standardisation of communication to enable one voice by government when addressing issues of public interest e.g. issue of internet shutdown.
  •  In the future, the government must find other ways of crisis management without shutting down the internet, as it has negative repercussions on business. Those who were affected by the internet shutdown are not necessarily those that abuse the internet.
  •  The cabinet/government must attend business meetings especially when invited to allow for better communication.
  •  Rules of engagement, the government must consult Zimbabwe National Chamber of Commerce (ZNCC) and Confederation of Zimbabwe Industries (CZI) to pioneer the interests of the private sector.

6. Politics

The political friction between the leading political parties, as well as political friction in the ruling party continues to increase the country’s risk profile. For years the economy of Zimbabwe has suffered from political instability and differences due to strikes and violence. Several infrastructures are damaged and a lot of business hours are lost during these activities.

Recommendations:

  •  A political dialogue in light of the ongoing unbearable economic challenges in the country is needed. The current situation requires solutions from all political sides to lift up the nation.
  •  There is need for all political parties and business players to recognise Emmerson Dambudzo Mnangagwa as the President while he also listen to different voices.
  •  The media fraternity should tone down on political issues.

7. Boarder Management Systems

Rampant smuggling at the border ports costs the economy about US$2 billion annually. This is due to under-declaration and false classification of goods by importers in an effort to evade paying the correct taxes as corruption continues to take its toll.

Recommendations:

  •  Have policies that do not promote informalisation e.g. foreign currency allocation system.
  •  There are too many tax agencies at the border which create room for corruption.

8. Public sector restructuring

State-owned enterprises/parastatals are a harbinger of inefficiencies.

Recommendations:

  •  Allow some of the parastatals to charge in hard currency (US$) or to raise their tariffs for sustainability e.g. Zesa may increase its tariffs from an average of $0,13 per kilowatt hour (KW/h) to $0,20/KWh
  •  Solve the currency issue before the privatisation of parastatals.
  •  Relevant parliamentary portfolio committees should be given powers to approve boards.

Summary

The crisis in the Zimbabwean economy can easily be transformed if the government, business member organisations, industry and the citizenry work together towards nation building.

For close to a decade, the political atmosphere, inconsistent policies, corruption and the recent currency distortions have increased our risk profile as a nation.

This paper presented some of the policy reforms and advice that the government may adopt for swift economic transformation.

Mugaga is an economist and CE of the Zimbabwe National Chamber of Commerce.

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