THE government’s ZW$18 billlion bailout package will almost be entirely funded by the Reserve Bank of Zimbabwe (RBZ) through new money creation (reserve money) whose implications we explore here.
Before the new money injection of ZW$18 billion, which we anticipate will be released gradually until the end of July, reserve money balance in Zimbabwe was sitting at ZW$12,4 billion in March. Adding ZW$18 billion brings the total to ZW$30,4 billion possibly by end of 2019, an annual growth of 200%.
A 50% annual growth in base money was accompanied by a 90% depreciation in currency in the prior year, but here a number of factors were at play which need to be discounted. It has to be noted that base effect had an impact on the pace at which the Zimbabwean dollar lost value.
The starting exchange rate of 1:2,5 was too low for an economy which had long overheated and in desperate need of hard currency, hence the quicker loss in value in 2019. Drought and Cyclone Idai funding, which would typically not have been anticipated, also spurred expenditure and RBZ’s money creation in the second half period of the year.
Into 2020, the RBZ and the Monetary Policy Committee highlighted that injecting new money into the economy through reserve money would cause high levels of inflation and exchange rate depreciation. It was agreed that money supply growth would be curbed to reasonably low levels, while the government was strongly urged to stick to budgeted expenditure. This was seen as a foolproof method of ameliorating exchange rate weakness. Money supply has thus been identified as the single most important driver of exchange rate losses and inflation.
Despite government’s pledge, the key challenge was a depleting aggregate demand and a deepening recession which called for an urgent intervention even before Covid-19 came into the matrix. Negative gross domestic product (GDP) growth of -9% in 2019 was worrying. Even after Covid-19, not a single economy globally except for Zimbabwe and a few other war-torn and sanctioned countries are expected to report such alarming GDP declines.
Such deep recessions demand government intervention through fiscus stimulus and other liberal monetary policy measures that help restore aggregate demand and reignite the supply side. But Zimbabwe is in a trap and this situation has been peculiar to this economy. Legacy debts from the Mugabe era make it impossible to access new liquidity from international financial institutions and this means the country could also be ineligible for Covid-19 grants being offered by these institutions at very favourable rates to member states.
Why are other economies not experiencing high inflation and exchange rate weakness after printing lots of money? The difference is that Zimbabwe has a traumatic history of inflation and moribund currency which drives perception and this fuels speculative hedging against the Zimdollar. Remember that the RBZ has no foreign currency reserves to cushion the currency when demand spikes.
We see the exchange rate moving towards 1:90 by the fourth quarter of 2020 if the government does not secure significant foreign currency funding of at least US$2 billion. Efforts to secure forex through the Victoria Falls Stock Exchange can only be long term and are unlikely to yield benefits until 2022. The slower relative depreciation of currency would be a result of channelling bailout funds towards working capital by some companies other than the speculative holding of forex, which would re-stimulate production and consequently feed into aggregate demand. This chain will however not be sustained as a quicker loss in currency value is anticipated ahead of the recovery in volumes.
We, therefore, see production and sales volumes recovering, but the duration of recovery will be short-lived and will not go beyond a few months. Beyond this point we expect the loss in currency to wipe out purchasing power and eventually drag volumes as demand plunges and planning becomes even more difficult.
Gwenzi is a financial analyst and managing director of Equity Axis, a financial media firm offering business intelligence, economic and equity research. — email@example.com