CENTRAL bank chief John Mangudya will have to make bold monetary policy decisions or risk the country sliding back into hyperinflation, analysts say.
Mangudya, who is yet to present his much-anticipated monetary policy, is expected to rein in inflation and resolve a deep-seated currency crisis, with analysts saying he may have to look at various scenarios to stabilise the economy.
Analysts say the currency crisis is at the core of Zimbabwe’s economic challenges characterised by cash shortages, price distortions, a multi-tier pricing system and fast- rising inflation, which is officially at 42,09%.
With Mangudya’s monetary policy still outstanding, what can the market expect from the central bank when he presents his policy and what scenarios may play out? There are questions galore. Will the government maintain parity between the US dollar and the bond note? Will the government introduce local currency? Can the government liberalise the exchange rate and to what extent—free float or fixed exchange rate?
What are the possible scenarios? According to Invictus Securities, Mangudya may have a few options at his disposal.
In a research note, Invictus Securities this week said Mangudya may be looking at introducing a new currency. “In our view, a decision by the RBZ to separate the FCA nostro accounts and local RTGS, compounded by recent upgrade of the RTGS platform to accommodate the US dollar nostro FCA transactions, further denies the parity position between the US dollar and bond,” Invictus said.
“Meanwhile, it has become inevitable and imperative for monetary authorities to consider currency reforms to resolve the toxic currency-related challenges in the economy. The current stance of a centralised foreign currency allocation is also not sustainable, hence the need to consider foreign currency market liberalisation.”
Local currency introduction
He can introduce a local currency,” Invictus said, “While economic fundamentals suggest that the debate on the introduction of local currency is premature and detrimental as it ignites reminiscences of the hyperinflation of 2008 era, where monetary investments, savings and assets were reduced to zero, it’s however worth looking at the possibility of such a scenario. In the prior recent years, government has assured the market that it will only introduce the local currency once the economy is healthy and certain fundamentals are strong enough to sustain the local currency.”
“In our view, the above evaluation clearly shows that economic fundamentals are still very weak, hence cannot sustain a local currency. Local production remains very low, culminating in a sustained trade deficit, whilst confidence level is also critically low. Government authorities need to seriously consider policies that enhance production and instill economic and market confidence. ceteris paribus, this should be attainable at least in the next two years, once the authorities consistently walk in the correct economic recovery trajectory. If government decide to introduce local currency within the next 12 months as indicated, it will be premature and has a danger of eroding all the economic gains achieved so far during the dollarised period.”
Invictus says should the local currency be introduced, liquidity and cash shortages would ease, banks would be able to meet cash withdrawals on demand, support exports, and end the multi-tier pricing model.
On the downside, a local currency in an inflationary environment will fast erode the value of assets and the value cannot be sustained, as production and investor confidence (local and foreign) remain critically low.
Mangudya could maintain parity between the US dollar and the bond note at a rate of 1:1 as is. “Monetary authorities, through the Monetary Policy Statement of October 2018 reiterated the parity position between the US dollar and bond, despite announcing the separation of nostro FCA and RTGS accounts. In the absence of an exchange rate proffered to bridge the flow of funds between the two separate accounts, this fuelled the US dollar parallel market rates. In the recent past months, the economy has strongly shown signs of a natural re-dollarisation process as most sections of the economy demanded real US dollar, or equivalent to settle payments,” Invictus said.
“We are of the view that currency reforms have become inevitable, as the market has defied the parity position between the US dollar and the local currency. Hence it might be disastrous for the government to blindly maintain the parity assumption, when the market is loudly behaving otherwise. Monetary authorities should somehow liberalise the exchange rate, that the market efficiently correct itself. This should restore market confidence, as the exchange rate will be efficiently and optimally determined by the market.”
Free float exchange rate
A free floating exchange rate is another scenario playing out. “The currency price is set by the forex market based on supply and demand. Government’s rationale behind free float or partial float would be to attract the parallel market premiums into the formal system which is taxable, thus increasing the tax net,” Invictus said.
This, Invictus said, will bring market efficiency. It requires less foreign currency reserves needed to regulate the exchange rate, reduces the need for frequent central bank intervention and enhances free flow of capital. On the downside, this increases uncertainty, may increase inflation and may encourage speculative behaviour. But Invictus noted that this regime works well where there is less intervention of the central bank.
Fixed exchange rate
Devalue the local currency at a fixed rate. According to Invictus, this helps avoid currency fluctuations, ensures stability in investments and keeps inflation low, with greater certainty for importers and exporters. But this makes it difficult to maintain the value of the currency and inflexibility makes it difficult to respond to temporary shocks. A fixed exchange rate, coupled by forex shortages, would create arbitrage opportunities and again sustain parallel market forex dealings.