IMF recommendations tricky

THE International Monetary Fund (IMF) told the Zimbabwean authorities that reserve money targeting was the only feasible monetary policy tool immediately available for the country to stabilise inflation and the exchange rate by extension. This recommendation is highly problematic.There are three broad options for a monetary policy framework, namely: hard pegs, inflation targeting and reserve money targeting.

The Brett Chulu Column

Two of these three options — hard pegs and inflation targeting — are not deemed feasible by the IMF at the moment for reasons we shall explore. We will deal with each option in turn.

Hard pegs out

Hard pegs is a class of monetary policy approaches that include the dollar-anchor, fixed exchange rate and the use of the currency board. These approaches require high levels of foreign currency reserves.

The IMF, under its Reserve Adequacy Mechanism, argues that an economy such as Zimbabwe that is fragile and has an unsustainable debt burden and has no access to concessional credit can adopt dollarisation when there are forex reserves of at least six months of import cover, not the traditional three months.

To sustain a fixed exchange rate, Zimbabwe would need forex reserves of at least five months of imports or 20% of M2 money supply. To successfully implement a currency board, our country would need at least one to eight months import cover, depending on whether the forex reserves adequacy calculation is based on the money base or the M2 supply of money.

The principal argument proffered by the IMF that neither the fixed exchange rate nor dollarisation nor a currency board are feasible in the immediate is that Zimbabwe has import cover of less than two weeks that is two to 16 times lower than the required thresholds. At times, our forex reserves have dipped to less than nine days.

In addition, it is argued that Zimbabwe’s poor record with inflation control means forex reserves much higher than the minimum thresholds are required.
It is interesting that the central bank is using a fixed exchange rate of 25 to the US dollar despite the fact that our forex reserves are close to less than one week. The fixed exchange rate the central bank is applying does not square with the thinking of the IMF on the matter.

It is such policy surprises that dent the confidence of both domestic and external markets due to economic distortions that arise transmitted as arbitrages. The economy is dollarised, partially and officially.

So we have a mix of three monetary policy frameworks at once, a situation that runs counter to accepted economic wisdom.A cross-cutting requirement for any of these three monetary policy frameworks to work is the independence of the central bank and its transparency. A currency board will require complete independence, making the central bank redundant. Our central bank is not independent in practice — it has been pointed out that the Reserve Bank Act gives Treasury powers in some instances to override the central bank. Politically, given our extractive politics and economics, a currency board is not feasible.

Inflation targeting out

Five pre-conditions must be met for inflation-targeting to be feasible as a monetary policy framework for Zimbabwe.First, fiscal prudence and fiscal sustainability are needed. Treasury has tried to bring about fiscal prudence but has been failed by the quasi-fiscal activities of the central bank such as the gold incentive. Guarantees of debt for private loans for Command Agriculture pledged by the government are a potential source of fiscal instability.

The external debt overhang of about US$10 billion owed to the international financial institutions and the Paris Club (grouping of country-to-country lenders) has starved Zimbabwe of fresh and affordable international credit lines.

This creates and sustains an ever-present and increasing pressure to drive the government to resort to creating unsustainable budget deficits.
The central bank is mooting the idea to adopt the losses banks incurred when their financial assets were converted at 1:1 following the floating of the Zimdollar in February last year. The IMF has strongly dissuaded the central bank from implementing the idea as this will create more public debt for the country.

Second, a stable and strong financial system supporting a functional inter-bank market is needed. The inter-bank forex market is not a mature market as it is dominated by trades directed by government – there are more willing buyers than sellers in that market.

The price discovery mechanism there is not transparent and is not subject to proper free market forces due to lack of transparency.
Third, a strong record of consistently delivering low inflation is an absolute essential. Confidence in the local currency is extremely low. Past monetary policy sins have spawned mistrust.

Unrestrained money creation regularly decimating the value of the hastily introduced local currency has been a major contributor to untethered inflation.
Clearly, these failures are the basis for the IMF’s argument that inflation-targeting as a monetary policy framework is not feasible.This leaves us with reserve money targeting as the most feasible option as per the IMF’s view. I find this problematic.

Reserve money targeting

Reserve money or base money is the total amount of currency in circulation and the reserves belonging to banks held by the central bank. These are basically the liabilities held by the central bank that support the creation of credit or money by banks.

The argument for reserve money targeting is that base money is directly under the control of the central bank and thus can directly influence broad money supply in the economy.

This is the reason why the recently established Monetary Policy Committee chose reserve money targeting as its flagship monetary policy approach.
Reserve money targeting works where there is fiscal discipline, central bank independence and central bank transparency.

These three essential ingredients are not there and cannot be guaranteed in future. Finance minister Mthuli Ncube’s letter importuning the IMF to have mercy on Zimbabwe indicates that there is immense pressure to resort to fiscal indiscipline and money printing to try and weather the deep recession Zimbabwe has been experiencing over two consecutive years.

There are three monetary policy frameworks to choose from. All the three seem not to be feasible.

I have a different view. Full official dollarisation is the only option now. As a transitional measure, full official dollarisation (conceptually defined as official substitution of a local currency with foreign currency), whether it will be a multi-currency regime, US dollar or rand, is now unavoidable. That will take away the government’s power to print money. The government will have to adopt cash-budgeting.

Chulu is a management consultant and a classic grounded theory researcher who has published research in an academic peer-reviewed international journal. —