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RBZ’s currency policy doomed to fail

Melody Chikono

THE latest move by the Reserve Bank of Zimbabwe (RBZ) to manage the exchange rate yet again is another experiment doomed to fail as laws of supply and demand will prevail.

Economists say Zimbabwe has never had a free floating exchange rate in the absence of upward and downward movement on the formal market that is normally consistent with a free floating market.

In response to a massive sell-off of the Zimbabwean dollar that saw the local unit plunge against the US dollar from around 1:11 to as high as 1:23 within a three-week period, the RBZ on September 27 2019, through an exchange control directive RU131/2019, fundamentally ditched the semi-free-floating system to a managed floating exchange rate.

Among some of the key changes, all foreign exchange transactions by banks and bureaux de change would be referenced to the inter-bank mid-rate which is published daily by the RBZ, and there would be a restriction on bank and bureau de change margins to 3% and 5% respectively from the inter-bank mid-rate published by RBZ.

Bureaux de change are now only restricted to buying and selling forex to individuals. Initially, the bureaux were allowed to buy free-funds from individuals and non-governmental organisations and sell to individuals, small and medium enterprises, businesses and personal travellers, as well as for international subscriptions for professional bodies, tuition and entertainment.

Immediately after the directive was issued, the exchange rate dropped from above ZW$20:US$1 on the black market to around ZW$16,5:US$1. However, the black market exchange rate has since last week rebounded to above 19 despite the shackles placed on banks and bureaux.

In contrast, the inter-bank rate has been stuck around ZW$15,3:US$1 for the better part of a fortnight.In light of all this, the central bank will only push the economy deeper into the parallel market, analysts say.

Africa Economic Development Studies (AEDS) executive director Gift Mugano said the country has always had a managed exchange rate despite claims it was free-floating.

He said the critical question at the moment would be whether the central bank could sustain it in the absence of adequate forex reserves.

“We had no free float in the beginning. When you have a free floating exchange rate regime, the rate should have a visible hand that allows the rate to fluctuate up and down. Zimbabwe’s inter-bank rate has been stuck for months. We would rather say we have a fixed rate. I don’t think anything has changed,” Mugano said.

“The question is: can Zimbabwe sustain it? Do we have enough supply of forex? The central bank should be able to release forex into the market when demand goes up to match the demand. For many years, we have always had at least three weeks’ reserves but we need at least six months to a year’s reserves to be able to manage foreign exchange.”

He said the central bank has no capacity to manage the exchange rate, adding this latest attempt would fail spectacularly.
Mugano said this was the reason Zimbabwe had a runaway black market.

“If you look at Angola, Zambia and Mozambique, who did that, they had reserves. In our case, the RBZ went on to introduce a currency without the backing reserves,” he said.

Economist Clemence Machadu said the monetary authorities should put more emphasis on ensuring that the Zimbabwean dollar first meets all the characteristics and functions of good money.

Machadu says this also ensures it has adequate foreign currency reserves to effectively manage this sort of regime before trying to fight the symptoms of a problem.

“I understand that this migration was necessitated by the rapid weakening of the Zimdollar, which has hitherto shed circa 140% of its value, which already indicates that the local currency is not stable. But it is not stabilised by trying to manipulate its value through a managed float, but by understanding what really determines the value of our currency and address that,” he said.

“Granted, there is need somehow for the monetary authorities to intervene with a view to containing the harmful effects of some fluctuations and to extricate the economy from exigencies. But what we should remember is that the managed float will not be the perfect forex allocation mechanism for the republic. It creates shortages on the formal markets as rational suppliers of forex will see an incentive to sell on the parallel market, as opposed to lower and controlled rates in formal markets. It also increases demand for forex on formal markets and arbitrage activities by rent seekers.”

Machadu said the central bank should also have adequate foreign currency reserves to effectively manage this sort of regime. He, however, said this was not the case.

A state of the economy report produced by AEDS says before the introduction of the new currency, the market was moving towards re-dollarisation as companies were moving to protect their working and fixed capital in the face of rising inflation and market exchange rate on a freefall.

“In light of the prevailing high inflation and foreign currency shortages, fiscal prudence and aggressive mopping up of excess liquidity by the RBZ should be the priority policy issues to anchor the currency stability and achieve price stability. The RBZ would need to consider more costless interventions to drain the market liquidity swamp. And raising the reserve requirements for banks to around 8% will be able to achieve that,” economist Brains Muchemwa in the report said.

Zimbabwe’s case fits in the classic first-generation model of currency crisis, which states that whenever government persistently spends more than it collects in revenues through a combination of money printing and central bank overdrafts while trying to maintain fixed exchange rate, the result is high money-supply growth, emergence of a forex parallel market and eventual official depreciation of the local currency.

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